Using a DAF to maximize giving

Ed and Beatrice are very comfortable financially, living well within the $60,000-$65,000 Ed receives and the $35,000-$40,000 Beatrice gets annually in annuities, government benefits and investment income.

Their Toronto home, which they bought for $15,000 65 years ago, is now worth about $550,000. They have $1.5 million in non-registered assets; of those, $400,000 is in blue-chip Canadian stocks with an adjusted cost base of $20,000. The rest is in bonds, bond funds and short-term guaranteed investment certificates. (These assets don’t include $600,000 from the recent sale of their cottage, which had an adjusted cost base of $200,000. The couple have not yet paid the capital gains taxes that are owing from the sale of the cottage.)

Ed and Beatrice have no children and want to donate most of their estate to three charities: a local hospital, a university and the Canadian War Museum. (Ed is a veteran.) The couple want their donations to be used to generate income for these charities for as long as possible, as opposed to being spent immediately.

The couple also would like to avoid clawbacks of their old-age security (OAS) benefits.

Ed and Beatrice are currently in good health. However, they know that one or both of them could need nursing care at some point. They would be prepared to pay $20,000-$25,000 a year for this.

The recommendations: Both Marek and Ortencio recommend that Ed and Beatrice make use of a donor-advised fund (DAF), a sort of “mini” charitable foundation that operates within a larger charitable organization registered with the Canada Revenue Agency (CRA). Under the CRA’s rules, at least 3.5% of the assets in the DAF must be distributed to designated charities each year.

Thus, as long as the DAF generates returns of 5%-6% per year, covering both the minimum annual payouts and the costs of administration, it can generate income in perpetuity.

Alternatively, individuals can set up their own private charitable foundations. However, that route involves a range of costs; legal fees to create the foundation and obtain charitable status from CRA, for instance, could be substantial. Other costs include annual audits, bookkeeping expenses and the preparation of tax returns. Such a route also means that someone must be appointed to run the foundation and make disbursements once the donors are deceased.

Thus it’s much simpler in most cases to use a DAF. Many organizations offer DAFs, including banks, some mutual fund companies, charities and public community foundations.

Ortencio recommends a DAF program offered by his company, which, he says, is “fully customizable while providing administrative efficiency, tax savings, expert charity evaluation and quarterly reporting.” Administered by BenefAction Foundation in Montreal, the Richardson GMP program will do all the work for Ed and Beatrice while also leaving the couple in control of how much money is disbursed and to whom (within CRA-imposed limits).

Marek suggests using the Toronto Community Foundation (TCF), a public entity that administers DAFs. The TCF handles all the paperwork and is accountable for its assets under management (AUM), which can be reviewed in its annual financial statements. The TCF, which was established by donors in 1981, has more than $255 million in AUM.

Both Ortencio and Marek advise an initial donation to the couple’s DAF of the $400,000 in blue-chip stocks. This eliminates the capital-gains tax liability, because donations of shares to a charity are not subject to capital gains taxes.

The DAF would then sell the securities and the proceeds would be reinvested. Both financial advisors suggest a target mix of 60% equities and 40% fixed-income, which is the asset allocation for DAFs required by most DAF administrators.

Donors to DAFs also can use their charitable tax credits to offset up to 75% of their net income in the year of the donation. So, Ed and Beatrice can use their tax credits of more than $100,000 to offset the $400,000 taxable capital gain on the sale of the cottage.

Other tax rules for DAFs include disbursing to charity at least 10% of lump-sum donations in the year they are made – in this case, $40,000. This would leave the couple’s DAF with $360,000 in the first year. Ed and Beatrice would decide how the initial $40,000 disbursement is to be distributed among their three target charities. The couple also can make this decision for annual disbursements as long as they live.

Ed and Beatrice also can make further donations to their DAF during their lifetimes. Or, they can wait until the death of the surviving spouse for the rest of their assets to go into the DAF.

BenefAction charges 0.5% a year for administration and a fee of up to 2% for lump-sum contributions, based on their size. Ortencio’s fees, in addition, would be 1%-1.5% annually for investment management, depending on the size of the portfolio. The TCF charges 1.5%-2% a year for all philanthropic and administrative services, including investment management.

Other DAF rules govern the asset mix. That mix must be conservative and stay within an allocation that is usually 60% equities and 40% fixed-income.

At Richardson GMP, DAF assets are managed in broadly diversified portfolios. BenefAction has an approved investment list but allows financial advisors to work with licensed portfolio managers, provided they stay within the investment guidelines.

The TCF allows donors to use their own investment advisors to manage the assets, as long as the advisors work at firms that meet certain criteria. These advisors must report to the TCF quarterly on the performance and risk in the DAF portfolio. The TCF also offers diversified investment management by six third-party firms, which the TCF monitors.

Ortencio targets a 6.5% return; BenefAction allows disbursements of more than the minimum 3.5% per year, at the discretion of the donors. The TCF, for its part, targets a 7.5% return and 4% a year in disbursements.

DAF donors specify which charities and what activities within those charities they wish the donated money to be used for. If a charity disappears or gets into trouble, there are alternatives. Either the donors – while alive, or the successors they have appointed – or the DAF administrators will disburse the DAF’s funds among the remaining target charities. A replacement also may be found, depending on the guidelines provided by the donors.

If no replacement charities are appointed initially, the TCF will discuss options with the donors. The TCF deals with more than 500 charities, for which it has done due diligence, providing a range of options for replacement charities.

In the case of Richardson GMP’s program, BenefAction would make the decisions regarding appropriate beneficiaries of the DAF’s gifts.

Ortencio recommends that a niece, nephew or lawyer be appointed successor decision-maker in Ed’s and Beatrice’s DAF. Marek suggests such a decision be left with the TCF.

While Ed and Beatrice are alive, Ortencio would leave their asset mix as it is because they are clearly comfortable with those securities. Thus, he would use the proceeds from the cottage to replace the $400,000 in blue-chip stocks donated to their DAF with the same securities. This would ensure that their dividend income remains the same. The adjusted cost base for these stocks would rise to $400,000 from $20,000.

When it comes to the couple’s bond funds, Ortencio suggests that Ed and Beatrice move these assets to more tax-efficient funds where taxes on interest payments are deferred until the fund units are sold. Or, if there are distributions from these funds, these would be viewed as return of capital. The fees on these funds would be slightly higher, but the tax savings “will far outweigh the additional costs,” Ortencio says. This structure also will reduce the possibility of OAS clawbacks.

Marek, however, sees no need to buy the same securities again, noting that they will probably be held in some of the funds he would suggest. Subject to consultation with Ed and Beatrice, Marek suggests a target asset mix of 35% equities and 65% fixed-income, invested in corporate-class, tax-efficient systematic withdrawal program (T-SWP) funds, which treat distributions as return of capital until the initial capital has been returned; this should ensure that the couple’s OAS benefits aren’t clawed back. Marek suggests the T-SWP be set up so that it allows for up to an 8% annual distribution. The couple would not need to take the full distribution, but this setup would put the couple in a position to increase what they receive should they need to pay for nursing care for one or both of them.

Both advisors suggest that Ed and Beatrice set up tax-free savings accounts, with their DAF listed as the beneficiary.

Marek suggests that the couple consult a lawyer to look into the title of their house to see if it can be excluded from the probate process. When Ontario changed to a new land registry in 2000, residences became subject to probate. However, there is a grandfathering clause that allows homes owned by the same owner prior to 2000 to be excluded from probate fees as long as certain conditions are met, including that there has been only one mortgage and no subsequent mortgages or home-equity loans.

Neither advisor would charge to develop a financial plan for the couple, as both advisors would be compensated through fees on the investments if managing the money. IE

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