How well do you know your client?
Raising the question of philanthropy when creating or reviewing a financial plan helps advisers build trust with their clients, and assists in the regulator-mandated ‘know your client' process, Tabitha Lovett writes.
With the issues of professional standards and adviser ethics being highlighted by the government's recent report into the financial industry, the role of financial advisers and the value they add is again under the spotlight.
Ensuring the advice provided satisfies each of the elements of the regulator-mandated ‘best interests duty' means advisers must complete a ‘fact find' on the client to ascertain their situation, objectives and needs.
They must also know the products they are recommending and the consequences of that advice, and they must ensure the advice is in their client's best interests.
Raising the option of philanthropy with clients has been shown to build trust and reinforce the importance of the adviser's role.
Reinforcing the trusted adviser role
In the ‘know your client' context, advisers have an obligation to add value and have a full understanding of their clients' wishes.
Having the conversation about philanthropy provides their clients with a greater understanding of the options available to them and provides advisers with greater insight into what makes their clients tick.
By undertaking a meaningful discussion with clients about their philanthropic objectives, it can provide greater insight into clients' financial objectives, and provide them with a real value added service.
Demonstrating expertise in structured, tax effective ways to give, and taking the opportunity to discuss philanthropy with estate planning clients has seen an increase in the number and amount of funds being directed towards charitable causes.
Our experience has been that one in five of all new wills written has contained a philanthropic intent, either a portion of an estate into an existing foundation or the creation of a new charitable trust or a charitable bequest.
This corresponds with research undertaken in the UK that if the option of leaving a bequest to charity is raised by an estate planner, the number of charitable legacies increases by around 20 per cent.
Despite their rising popularity, there is still a perception that charitable trusts are just for the very wealthy. Not true. You don't have to be a Murdoch or a Myer to set up a charitable foundation.
It is easier to establish a perpetual charitable foundation than most people think and it does not need to be expensive or complicated. A donation of $20,000 is enough to seed and establish a philanthropic vehicle.
The charitable giving options
Typically, there are three main types of charitable vehicles available: private ancillary funds (PAFs), sub-funds with public ancillary funds (PUFs) or testamentary charitable trusts.
Overall, a sub-fund with a public ancillary fund has significantly lower start-up costs than a private one. Establishing a PUF provides all the benefits of a PAF but simplifies the administration and reduces costs as the expense of audits, tax reporting and administration are spread across the foundation as a whole, rather than by the individual sub-funds.
That is to say, it is a simple, effective way to leave an enduring legacy without the responsibilities of maintaining a foundation.
Donors who use this structure for their charitable giving make their donations directly to their sub-fund and receive a tax deduction for each donation.
Their donation is then invested in a managed fund designed specifically to meet the needs of charitable foundations (healthy income yield and capital growth to stay ahead of inflation) and all income and capital growth of their sub-fund's investments is tax free, as PUFs are endorsed by the Australian Tax Office as tax exempt.
This means that the donor gets their full tax deduction for donations and their donation continues to grow in a tax-free environment, increasing the income which they can give away each year to the charities and causes about which they are passionate.
The trustee of the PUF manages the investment, governance and administration, and the donor is then freed up to focus on the rewarding part of being a philanthropist — thinking about the issues in their immediate community or problems in the world they would like to support or tackle.
PAFs, on the other hand, are often used for family foundations. PAFs are suitable for those who can donate at least $300,000 in investible assets.
The income generated by a PAF's investments is tax-free so that funds available each year are not depleted through tax. There are currently more than 1,200 PAFs in Australia which distribute around $200 million annually to charitable organisations.
Giving after death
Testamentary charitable trusts are the traditional way of leaving a lasting legacy and are a common vehicle for distributing funds to charitable organisations and causes.
The difference from the other two options outlined above is that beneficiaries don't have to be a deductible gift recipient, widening the options for giving (i.e. to individuals for scholarships).
Income produced within the trust is tax-free but the initial establishment amount is not tax deductible as the trust comes into effect on a person's death through their estate. This means the benefactor doesn't have to be concerned with the consequences of gifting money during their lifetime or being involved with the trust's administration.
Changing trends
The beauty of philanthropy is that philanthropists' objectives are unique and we find they are keen to share their philanthropic goals and dreams of change.
Granting distributions from trusts have evolved to be more strategic and sophisticated in recent years.
Clients and their advisers are increasingly informed and thoughtful about what they expect to achieve when they set up charitable trusts, which in turn encourages more flexibility in the way distributions are made.
At the same time, while interest in philanthropy is expanding, grant recipients' needs are also changing.
As a result of these two trends, many trustees' companies and other charitable trust managers are taking a multiyear view on their work, rather than making annual ‘one off' distributions.
Understandably, we are also seeing more grant and donation requests from the charity and not-for-profit sector looking for alternative funding where government cutbacks have resulted in reduced funding.
The area of health and medical research reflects both of these trends. Researchers need to have confidence that funds will be available, not just for one year but for the anticipated life of a research project.
Trustee companies endeavour to provide this longer-term support if the terms of the charitable trust allow it, and after due diligence and risk assessment.
Another approach that has evolved in recent years is for charitable trusts to provide seed grants or no-interest loans to enable an organisation to set up a community social enterprise program that will provide a revenue stream for the charity.
This approach also involves another innovation: working with other philanthropic and government organisations to provide sufficient capital and manage risk for such charitable programs.
Monitoring
Trustees companies require charitable organisations to submit progress and acquittal reports each year on how the grant funds have been expended.
The advantage of receiving the reports is that a philanthropist can track and evaluate the outcomes achieved with their grants, which in turn inform decisions about what projects or charities to support in future years.
Distribution requirements
There are specific but different distribution requirements for a PAF and a PUF. The advantage of using the PUF sub-fund option rather than a standalone PAF is that a PUF has lower minimum distributions requirements, allowing a donor to build the capital of the fund.
PUFs must distribute the equivalent of four per cent of the fund's market value (capital and income) each year whereas PAFs are required to distribute five per cent of market value.
Ensure your trust has the appropriate underlying investment
Considering that between four to five per cent of the fund's market value needs to be distributed each year, the fund needs investment return in excess of this amount if it is to be of a perpetual nature.
This means that a conventional perpetual trust must have a reliable dividend yield higher than the equity market as a whole, so franking credits are often very important.
Good asset allocation is also vital — a diversified growth fund is a good place to start. This will revolve around a core Australian equity allocation with a focus on defensive sectors that generate reliable dividends while, at the same time, balancing capital gain and incomes with a low level of risk.
Of particular note in recent years is the increasing demand for funding from charities.
The number of requests for grants from charities is on the rise and the ratio of the funds requested against the income we have to distribute is around 8:1. This demand from the charitable sector is increasing, not decreasing.
While government and private sector funding for charities can ebb and flow, the proceeds from perpetual charitable trusts continue to be distributed, regardless of the financial climate or government funding priorities, which is a good thing for the charity sector and the community they support.
Tabitha Lovett is the general manager, philanthropy, at Equity Trustees.
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