The mechanics of charitable investing

Tabitha Lovett explains how to help clients understand the options available to them when it comes to charitable investing.

As more baby boomers approach retirement, there is increasing emphasis on transitional strategies that include financial arrangements to take care of a number of needs, including estate planning.

For clients who have more than sufficient funds to provide for the retirement lifestyle they wish for (as well as meeting other family obligations) and have a desire to give something back to the community, there are a number of alternatives available.

Such clients may be guided by a general philanthropic sensibility or a desire to support a specific cause, such as medical research into a condition that has affected them or a family member, environmental protection or a community activity.

Most people in this position still think in terms of a donation in their will to a favourite cause or charity. However, there are other philanthropic approaches and vehicles that allow individuals – who may not see themselves as extremely wealthy – to either pursue their philanthropic goals during their lifetime while maximising tax advantages, or to set them up as part of their estate planning.

It is easy to dismiss charitable foundations as the preserve of the very wealthy, but this is not the case and the advantages of using a charitable foundation should not be ignored in financial planning.

Charitable approaches that involve the donors during their lifetime could appeal to many in retirement who have funds available for philanthropic purposes.

Clients can set up a charitable fund, which can operate without their ongoing involvement, or that can allow them to play an active role in selecting which projects to finance as well as providing involvement in the fund’s income distributions each year. 

According to circumstances, there are generally three main types of charitable fund that can be set up by individuals and families.

They are: 

• Private ancillary funds (PAF – these are what most people understand to be a charitable foundation); 
• Charitable accounts (which are the individual funds set up under the umbrella of a public ancillary fund); and
• Testamentary trusts (set up in an individual’s will).

Clients who want to set up a foundation in their lifetime, and have sufficient capital to live on in retirement and look after family obligations, should consider an Australian Tax Office (ATO) endorsed PAF. There are a number of financial advantages available to those who set them up, including:

• The initial start-up capital is tax deductible; 
• Income is generated in a tax-free environment; and
• Further donations to the fund can be tax deductible.

Provided the donation made is money or property valued by the ATO at more than $5,000, a donor can claim the tax deductions in the income year in which the donation is made, or spread the deduction over the four income years immediately following the donation.

Other benefits, although less tangible, are nonetheless compelling. Setting up a charitable fund during their lifetime allows clients to have involvement in their philanthropy, see the difference their gift has made, and involve family members in their philanthropic vision. 

PAFs are required to distribute 5 per cent of the overall assets held in the fund each year (with a minimum distribution of $11,000) and founders can choose the organisations they want to receive the funds – provided the recipients have been given ‘deductible gift recipient’ status by the ATO.

To achieve this level of distribution and justify annual audit and administrative costs, a starting capital of around $300,000 (possibly spread over a few years) is required for a PAF to be sustainable.

If clients do not have the funds to establish a PAF there are other options available – such as setting up a charitable account with a PAF.

Clients who do not want to start a charitable foundation in their lifetime, but who do wish to leave an enduring charitable legacy, can establish a testamentary trust under their will. These trusts are less susceptible to change in government regulation, may have lower ongoing administrative costs, and are only required to distribute income (rather than a minimum percentage) of their assets each year. 

Testamentary trusts are often referred to as ‘perpetual charitable trusts’ since the law allows their capital to be preserved indefinitely. Advice should be sought in setting up such a trust to ensure that it can operate in perpetuity in the way the donor intends.

When considering either PAFs or testamentary charitable trusts, thought should also be given to succession arrangements as trusts may well continue for many generations, if not perpetually. Appropriate arrangements need to be made to ensure ongoing administration in accordance with the founder’s wishes.

Philanthropic giving is a personal choice and can take many forms. Establishing a charitable fund or account can provide many benefits in the form of tax deductions and in estate planning but, most importantly, it can provide a philanthropic legacy for the benefit of future generations.

Tabitha Lovett is head of philanthropy services at Equity Trustees Limited.