Start Your Own Charity

Irving Kempner, the son of Holocaust survivors liberated by the U.S. Army, shows gratitude for his good fortune by giving to the American Jewish Committee, the U.S. Holocaust Memorial Museum and other charitable causes. When Kempner, a 59-year-old retired corporate executive (he was a vice-president of Gillette and chief executive of LoJack, the car-security company), makes grants, he does so through the Kempner Family Foundation.Kempner's "foundation" is actually a donor-advised fund, an account designed for philanthropic giving that is administered by a charity. Donor-advised funds provide more-attractive tax advantages than private foundations and are usually cheaper to operate. If you want to set up a family charitable fund, a donor-advised fund will likely meet your needs. But for some people, a family foundation may be a better way to go.

One critical factor is how much and how often you give. For instance, you should expect to set aside at least $5,000 to start a donor-advised fund sponsored by a financial firm. Many community foundations can set up a fund for $1,000 or less if you give regularly. But it usually takes at least $250,000 in assets to make a private foundation worth the cost.

If your giving patterns are the same year after year, "go with a donor-advised fund," says Chuck McLean, vice-president for research at GuideStar, which tracks charities. "Go with a family foundation if you want maximum control and maximum investment options."

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Advantages of a fund

Kempner is eligible for an immediate tax deduction -- up to certain limits -- for cash, stocks, bonds and other assets he puts into the fund, which is sponsored by Combined Jewish Philanthropies of Greater Boston. The market value of his gifts goes into diversified investment pools offered by the fund. He can then select the charities that receive grants, but his requests must be approved by CJP, which legally controls the assets. "When I make a grant, it is not automatically rubber-stamped," says Kempner. "CJP makes sure it is a legitimate agency." Funds usually approve a donor's grant -- Kempner has never been turned down -- as long as a charity has 501(c)(3) tax-exempt status.

Many types of charities, including more than 700 community foundations, sponsor donor-advised funds. With $3.7 billion in assets, the Tulsa Community Foundation is the largest such organization in the country. A fund may be affiliated with a religious organization, such as the Catholic Community Foundation, or an educational institution, such as the University of Florida. Some of the largest donor-advised funds are administered by charities set up by financial-services firms, such as the Fidelity Charitable Gift Fund, the Schwab Charitable Fund and the Vanguard Charitable Endowment Program.

Donor-advised funds give you more-generous tax breaks than family foundations. For example, you can deduct the value of cash gifts to charities up to half of your adjusted gross income, compared with a deduction of up to 30% for cash gifts to charities from a private foundation. Gifts of stock and property also receive favorable tax treatment: With a donor-advised fund, you can deduct the value of such gifts up to 30% of your AGI, compared with up to 20% with a private foundation. Plus, if you go with a donor-advised fund, you avoid an excise tax of 1% to 2% on net investment income levied annually on foundations.

Managers of donor-advised funds point out that the funds are also less expensive to run than small family foundations. "With administrative expenses that are 20% lower than private foundations, the Gift Fund allows more dollars to go to the charities themselves," says Sarah Libbey, president of Fidelity's donor-advised fund.

In addition, donor-advised funds offer more leeway in setting your giving timetable because you're not required to make grants every year. That said, the largest donor-advised funds typically grant 20% of their assets annually; funds sponsored by community foundations give about 15% of their assets each year.

Because donor-advised funds have so many advantages, Libbey expects a 40% increase in the number of foundations that Fidelity will convert to funds in 2009 compared with last year. Such conversions are irreversible, and the rules for closing foundations vary from state to state, so it's important to consult an attorney. Many funds will help you with a conversion, which should cost about $5,000 for a small foundation.

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The case for foundations

Why choose a private foundation over a donor-advised fund? In a word, flexibility. Because charities overseas do not have 501(c)(3) status, it's tough to give internationally with a donor-advised fund.

Also, legal hurdles prohibit funds from hiring staff or paying family members who help support your charitable work. You'll face similar restrictions if you want to provide scholarships or hardship loans.

On the downside, a private foundation must distribute 5% of its net asset value annually, regardless of how well its investments perform.

And small private foundations pay as much as 2.5% to 4% of assets annually in overhead. But outsourcing paperwork can cut costs. For example, Foundation Source, the largest provider, charges $4,500 per year, plus 0.35% of assets, in administrative fees for foundations with assets of $500,000 or more. Even after paying a $4,750 setup fee, you'd still spend less than if you administered your own foundation.

Watch those fees

Donor-advised funds and private foundations have two layers of fees. The administrative fee covers the costs of grant-making operations and maintenance, and it is based on the size of your largess. You generally need more than $500,000 before you qualify for lower administrative fees from a donor-advised fund. Foundation Source starts reducing its administrative fees once a foundation reaches more than $10 million in assets.

The investment fee pays for the management of the fund's or foundation's assets. Investment fees charged by donor-advised funds are comparable to those of mutual funds. Fees are usually higher for stock investments and more-aggressive portfolios. A donor-advised fund will typically lower your investment fees if you have an account balance of $500,000 or more.

With private foundations and some donor-advised funds sponsored by community foundations, you may choose the manager; your fees will be based on the amount being managed.

Other fund benefits

Fees are only one consideration when it comes to choosing the best way to give. "I caution people who focus on the fee to make sure they are very clear about what type of support they are and are not getting," says Virginia Esposito, president of the National Center for Family Philanthropy.

The largest donor-advised funds allow donors to make grants easily. "It takes fewer clicks to issue a grant from your fund than to give money to a charity with a credit card," says Kim Wright-Violich, president of Schwab Charitable.

Opening a donor-advised fund with a community foundation offers yet another advantage: an insider's view of the local philanthropic scene. For instance, the Greater Kansas City Community Foundation provides those with accounts an online database of local charities that includes financial information as well as details about a charity's effectiveness. "With private foundations, you have to do the legwork yourself," says Laura McKnight, head of the Kansas City foundation.

NEXT: See What You'll Need to Get Started in donor-advised funds.