Why Have a Private Charitable Foundation?

Why Have a Private Charitable Foundation?

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A private foundation, sometimes called a “family foundation”, is a type of registered charity. Private foundations do not undertake charitable activities directly. Rather, private foundations simply fund other registered charities. Unlike public foundations, private foundations can be controlled by a single individual or connected groups of people.

This post describes why investors may want to maintain a private foundation. This post also compares private foundations to Donor Advised Funds – an important distinction. Investors could use a DAF instead of a private foundation in most cases.

A DAF is a type of charitable foundation that pools the charitable funds of many account holders. Think of a DAF as a mutual fund for charitable funds or as a “a private foundation in a box”. While a mutual fund pools the investments of many individual investors, a DAF provides the same benefits of scale to charitable endowments.

Here are the 6 main reasons why investors should maintain a private charitable foundation (or DAF):

  • Earn tax free income
  • Issue charitable receipts
  • Reduce fees/expenses
  • Support intergenerational wealth transfer
  • Implement customized investment policies
  • Coordinate charitable giving

Earn Tax Free Income

The first, and most important reason to create a charitable endowment using either a private foundation or a DAF is to earn tax free income. This is because private foundations are not required to pay tax on the investment income they earn. This includes dividends, interest, capital gains, and most other investment income.

Since they don’t pay income tax, private foundations can devote more of their resources towards charitable purposes. Income earned in a taxable account (like your own name or a corporation) means some of that income will go to government. But, income earned inside a charitable foundation is not taxed. So, investing capital earmarked for philanthropy using of a charitable foundation means more capital for philanthropy and less for government.

Issue Charitable Tax Receipts

The second most important benefit for maintaining a private foundations or DAF is their ability to issue charitable tax receipts for donations. This means, when you donate cash or other assets to your private foundation or DAF account, you receive a tax benefit. The benefit comes in the form of a charitable tax credit. The exact benefit depends on several factors including the amount of your gift(s) and your income tax rate (or amount of tax owed).

Reduce Fees/Expenses

A good reason to maintain a private foundation instead of using a DAF is to reduce fees & expenses. But, not all private foundations operate efficiently. The operational strategy of a private foundation will determine whether its more cost efficient than a DAF. In many cases, using a DAF is more cost efficient. A private foundation must be cost efficient to make it better than a DAF.

When comparing costs of private foundations vs DAFs, let’s remember that private foundations should not have any business activities. The primary reason for private foundations to exist is to earn tax free income on their investments and to issue charitable tax receipts for donations. Investors can also get these same benefits by using DAFs. If a private foundation cannot keep costs low, especially including investment management fees, then oftentimes its cheaper to use a DAF instead of a private foundation. Especially when considering the cost of time.

Unless you can make your private foundation more cost effective compared to a DAF, the only other reasons to create a private foundation might be the following:

  • Support intergenerational wealth transfer,
  • Implement customized investment policies and,
  • Co-ordinate charitable giving with family members and colleagues.

Unless your private foundation operates on a low cost base and considering the time and responsibility of maintaining a private foundation, most donors are better off using a DAF to achieve the same philanthropic goals.

Here are some other ways to leverage your private foundation.

Support Intergenerational Wealth Transfer

A big benefit to using a private foundation is to support intergenerational wealth transfer. At first, this might seem like a strange claim since the capital owned by a private foundation cannot be used for private benefit. But, the skills required, and the experience gained by maintaining a private foundation can be used more broadly for other aspects of wealth management.

One of the main challenges of transferring wealth to future generations is finding ways for engage the next generation in a wealth management process. A private foundation is a good sandbox for future generations to hone their skills & experience. Areas of focus might include:

  • Governance
  • Investment Policy
  • Giving Strategy
  • Administration
  • Compliance

Implement Customized Investment Policies

Some DAFs allow account holders to use 3rd party investment advisors to manage their endowment. But many DAFs restrict the investment choices their account holders have. And, even if a DAF allows for 3rd party investment management, the investments allowed must comply with an overarching investment policy set by the DAF.

But, private foundations have much more freedom to customize their investment strategy. How they might do this depends on the foundation’s goals. For some, this might mean holding more values aligned investments, impact investments, mission-based investments (such as loans to other charities), private mortgages, direct ownership of things like gold & bitcoin, and using various investment styles (such as unique trading strategies).

For investors with strong opinions about investing, having a private foundation allows for full customization so long as the investments the foundation makes comply with prudent investor rules and other rules set out by the CRA.

Coordinate Charitable Giving

A fun aspect of charitable giving is pooling the funds of family members and/or colleagues to share and amplify charitable impact. For example, if you go to a charity offering a donation of $10, you might not get their attention. But, if you go to a charity offing a donation of $10,000, you might find your influence grows. By coordinating your donations using a private foundation or DAF, donors can sometimes influence charity donees in a way that amplifies your charitable impact.

Private Foundations Have Some Creative Scope

With private foundations, so long as accounting methods are in place to comply with CRA standards, there is wide latitude to get creative in other ways. For example, a private foundation can keep their own internal investment accounts for individual family members, fundraising targets, etc. These strategies can tie into supporting intergenerational wealth transfer too. Such creativity is not necessarily supported by DAFs.

Philosophically Speaking

Philosophically, many of us believe it is better to take responsibility for our own wealth directly rather than outsource it to 3rd parties. This is another reason to use a private foundation compared to a DAF. With a private foundation, families and colleagues can take direct responsibility for their charitable capital including the administrative and compliance work involved. This is good because doing so allows the next generation to acquire the skills & experience required to successfully transfer wealth.

But, what is the main reason why people ACTUALLY create private foundations?

Reputationally, many philanthropists want their own private foundation to show others and promote their objectives.

Using a DAF can be largely anonymous. Whereas a private foundation can have your name on it.

Pass the Buck

A final reason to have a private foundation is to deflect charitable solicitations. When a charity asks you for donations, you can refer them to your private foundation, who presumably has a process in place to manage giving.

Our Passion

One of the passions at our family office is supporting private foundations. In our experience, many private foundations waste charitable resources on too much administration, accounting, and especially on investment fees. Private foundations can be very simple to operate. But, it takes a certain type of strategy and set of operating procedures to make this so.

If you have a private foundation and would like an objective review, our family office will suggest strategies for improvement based on your goals & values. Please get in touch with us.