By Dennis R. Delaney
Have you heard of "affluenza"? A catchy phrase during the technology boom years, you don't hear it spoken much anymore now that the tech boom has gone bust, along with many other sectors of the economy.
Even so, mindful that we are amidst the largest generational transfer of wealth in recorded history — up to $136 trillion according to one recent study — those of us in the estate planning and financial fields are likely to see the effects of affluenza for years to come.
This "malady" is easy to diagnose; the first symptom seems benign — sudden acquisition of wealth — but later symptoms can include familial difficulties, lost or damaged friendships, guilt and a lost sense of direction. The causes are not a mystery: inheritance, entrepreneurship, divorce, savvy investing and plain old luck can all be contributing factors.
Individuals afflicted with affluenza may not immediately recognize the symptoms, concentrating instead on the wonderful opportunities that wealth can bring. Still, some experience an immediate sense of dread upon realizing they have become very wealthy. In any event, sooner or later, they will encounter a host of psychological and emotional challenges as they come to terms with their new status.
Affluenza can creep in when your clients begin to wonder why they struck it rich and others did not, and when their children face jealousy at school or on the playground from playmates who have learned of their good fortune.
Symptoms may intensify when worries set in that the children may never acquire the drive necessary to succeed if they lose touch with core values or become accustomed to a life of luxury.
Now, don't scoff at the notion that sudden wealth may bring burdens along with its blessings; affluenza can actually be quite serious for those it strikes. In fact, this scoffing and other subtle forms of distancing by friends and associates is yet another element of affluenza.
Combating 'Affluenza'
So how can you, as an advisor, help your client? Talking to them about charitable giving is one way. In fact, many have become intensely engaged in philanthropy as a way to combat affluenza.
These individuals often follow the lead of the titans of the "old" economy by setting up their own charitable entities, which in turn make multiple distributions to different public charities over time.
Why don't clients simply make gifts directly to charities instead of setting up some form of entity that distributes to charities? There are a number of reasons.
One is that these entities allow the client and his family to participate in a long-term charitable giving program, helping family members connect and share a sense of purpose through the generations.
Another reason is that donors find working through these entities to be more satisfying because they allow the donors to put a personal touch on their giving, to be flexible in their philanthropy, and to interact more with the people who run the benefited charities. All of this provides the donor with greater degree of involvement and opportunity to impact the charities.
Being new at large-scale charitable giving, those who have experienced sudden wealth are less likely to be bound by a tradition of family giving to a particular charity. As a result, many of these "new" donors may be more likely to cast a critical eye on the charity's performance, which in turn may make them more likely to switch allegiances if they are not satisfied with the results they see. Creating their own charitable entity to manage their giving enables them to do so.
Four of these entities — private foundations, donor-advised funds, supporting organizations and charitable lead trusts — are proving to be particularly popular with those making charitable gifts with a desired return on investment in mind.
Private Foundation
The private foundation is popular because it allows the donor not only to make decisions with regard to charitable distributions, but also to decide how to invest the assets that are not yet distributed to charity.
There are limitations on each of these powers, such as the rule that generally requires a private foundation to distribute at least 5 percent of the fair market value of its assets each year, but these limitations rarely pose a problem for donors with charitable programs in mind.
Private foundations are a great way to remove highly appreciated stock from the donor's estate, but beware of the limitation that forbids the foundation from holding more than 20 percent (in some cases 35 percent) of the voting interest of a corporation or partnership.
For the client looking to leave a lasting legacy, the permanence of a private foundation will likely be especially attractive as it affords the donor the opportunity to carry on his or her good work and family name for generations to come.
Also, contributions to a private foundation are tax-favored, being fully deductible for income tax purposes (but only to the extent the deductions do not exceed 30 percent — and in some cases 20 percent — of the donor's adjusted gross income) and for gift, estate and generation skipping tax purposes.
Still, private foundations can be costly to set up and administer, and thus may not be cost efficient for a smaller fund — generally less than $1 million. They are also closely regulated by the IRS with penalties that can be severe for violations, and are subject to a 2 percent excise tax on investment income.
Donor-Advised Funds
Some donors have opted instead to set up donor-advised funds. Under this arrangement, a public charity, such as a community foundation, sets up an account for a donor, accepts the donor's gifts to the account, manages the money, and generally makes distributions to whatever charity or charities the donor recommends.
Some donor-advised funds provide additional services, such as researching charities, staying abreast of work done in certain charitable sectors, and helping to educate the donor and his family about philanthropy. Other funds merely provide a telephone staff to take donors' calls when they want to make a distribution.
As for investing the funds that are not distributed, the donor typically may select from a group of mutual funds, whereas the donor of a private foundation enjoys more flexibility over investment decisions.
Donor-advised funds offer greater tax advantages than private foundations because a donor-advised fund is treated as a public charity. Therefore, cash gifts to a donor-advised fund may be fully deducted for income tax purposes so long as they do not exceed 50 percent of the donor's adjusted gross income, as opposed to 30 percent for gifts to a private foundation.
Stock gifts to a donor-advised fund also enjoy a tax advantage over stock gifts to a private foundation.
Supporting Organization
Another alternative to a private foundation is a supporting organization, an entity that supports a particular public charity or charities.
For the donor who wants continuing control over his charitable giving, the typical supporting organization is more limited than the other three entities because it exists to support a particular charity or charities and may not make any distributions to any other charities.
On the other hand, a supporting organization may offer more opportunity for regular interaction with those who run the charity receiving the distributions.
Like the donor-advised fund, a supporting organization is considered to be a public charity, so it offers greater tax advantages than a private foundation and is not subject to the voluminous regulations that govern private foundations. Of course, a supporting organization is subject to its own considerable set of IRS regulations.
Charitable Lead Trust
A fourth entity that has gained in popularity over the past few years has been the charitable lead trust. There are two types of charitable lead trusts: the annuity trust and the unitrust.
The annuity trust "leads" with distributions of a fixed amount to charities for a set period of time — either a number of years or during a named individual's lifetime. Ultimately, the trust distributes to non-charitable beneficiaries, usually the donor's family members.
The unitrust also leads with payments to charities and ultimately distributes to non-charitable beneficiaries, but the amount of the charitable payment varies each year according to the trust's investment performance.
The charitable lead annuity trust has been very popular of late as low interest rates make it a powerful estate planning tool, enabling the donor to make charitable gifts and also to pass assets to descendants at reduced gift and estate tax rates.
The charitable lead unitrust is not as sensitive to interest rates, but it may be an effective estate planning vehicle if it is set up as a long-term "dynasty" trust that benefits family members for generations after the charitable payments terminate.
Emotional And Psychological Challenges
All four of these entities allow donors to maintain a high degree of involvement with their favored charities. Each can be used to research charities, allowing the donor to give to the charity that presents the best prospects for strong results. If the return on this investment does not materialize, the donor can discontinue the funding and move on to a new public charity.
A private foundation, charitable lead trust or supporting organization with enough funding will also enable the donor to develop a constructive relationship with those who run the benefited public charities.
For instance, a college president may join the donor and the donor's family in serving on the board of a supporting organization established to support that college. In contrast, a donor who writes a check to the college directly has relatively little opportunity to work with its president; he would likely see the president once or twice a year at banquets.
But how do these entities allow the newly wealthy to help their family cope with the emotional and psychological challenges that affluenza brings?
For one thing, the entities provide a way for the family to connect in a shared enterprise to do good. The private foundation, donor-advised fund or charitable lead trust all can involve using a family committee to choose which charities will receive distributions, creating an opportunity for members of the donor's family to get involved with philanthropy and to work together on a common task.
Some even make running the entity their career and treat it as a family enterprise. Donors bring their children to site visits to see where the money goes or to lend a hand with the charity's work and the children also conduct research on their own and help make distribution decisions.
These families are also teaming up with donor services organizations or financial institutions to help educate their children about the responsibilities of wealth, to reinforce a strong value set, and avoid the dangers that money can bring.
Some also provide forums for the family to meet, either among themselves or with others who are similarly situated.
In short, many who have experienced sudden wealth have found that philanthropy conducted through their own charitable entity can be just the right medicine to ease their transition into a new economic order and ameliorate some of the unpleasant side effects that can accompany wealth.
Dennis R. Delaney is a lawyer at the Boston firm of Hemenway & Barnes, where he concentrates on estate planning and fiduciary matters, as well as probate and taxation.
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© 2002 Lawyers Weekly Inc., All Rights Reserved.
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September 30, 2002
