Key Takeaways:

Introduction

People often think of charitable structures as short hand for philanthropy— but they can often be tax mitigation tools that can help build you/your family’s wealth more efficiently. You might want to make a significant charitable impact, build family wealth, create a legacy, or engage the next generation in giving. Every charitable structure comes with its own rules, advantages, and trade-offs.

If you’re considering a structured approach to giving, you’ve likely come across several charitable vehicles (the below list goes from most philanthropic and least personally beneficial to most personally beneficially and least philanthropic):

1. Donor-Advised Funds (DAFs)
2. Private Foundations
3. Charitable Lead Annuity Trusts (CLATs)
4. Charitable Remainder Trusts (CRUTs)

But how do you decide which structure is best for you and your family? It depends on your personal situation, income, net worth, how much control you want to retain, and how you want to balance philanthropic benefits with personal (or familial) financial benefits.

In this article, we’ll explain the high level use case for each structure, walk through a case study illustrating those benefits before diving into the mechanics, the pros and cons, and key considerations for each. Let’s help illustrate what the financial implications of each of these charitable structures would be in the same situation.

Case Study

Shailene and Omar are married with three kids and live in California. They have already set up trusts for their kids and used both of their lifetime gift tax exemptions. They have $10 million of Nvidia shares with a $1 million cost basis. They want to sell the shares, give some to charity but also pass on some of the proceeds to their children but aren’t sure of the financial implications of the different options. Below we lay out the financial implications for the family and charity over the course of 25 years, assuming the reinvested assets grow 9% per year.

As you can see, the different structures produce very different quantitative outcomes. Their family benefits the most with a CRUT, while charity benefits the most with a DAF or foundation. And a CLAT is a middle ground that somewhat benefits both charity and the family.

What structure Shailene and Omar (and potentially you) choose to use is entirely dependent on what goals you are prioritizing. To help you better understand these structure’s let’s dive into each of them.

Donor-Advised Funds (DAFs)

A Donor-Advised Fund (DAF) is a charitable giving account that you set up under the umbrella of a public charity, often managed by a financial institution or community foundation. Think of it as a special-purpose investment account for your philanthropic goals.

When DAFs Make Sense

• If your sole priority is philanthropy and you don’t intend to retain any control or benefit from the assets.
• If you want simplicity and don’t want to worry about administrative hassles.

How DAFs Work

1. Establishing a DAF: You choose a sponsoring organization (such as a large financial institution, a local community foundation, or an online DAF provider) and open a donor-advised fund in your name or your family’s name.
2. Contributing Assets: You can transfer cash, appreciated stocks, or other assets into the DAF. Once contributed, those assets technically belong to the sponsoring organization, but you retain “advisory privileges.”
3. Investment Growth & Fees: The assets in the DAF can be invested. Any growth in the account is tax-free but providers typically charge around 0.5% of assets annually.
4. Grant Recommendations: You (or anyone you designate) can recommend grants to qualified charities from your DAF. The sponsoring organization has final say, but in almost all cases, they follow your recommendations.
5. Ongoing Account Management: You don’t have to distribute the assets immediately, and there is no official deadline by which grants must be made. Many families contribute assets to a DAF year after year and then distribute grants over time.

Pros of DAFs

1. Simplicity: DAFs are relatively easy to set up. Typically, you can fill out some paperwork or complete an online application, fund the account, and be ready to make grants to charitable causes in days.
2. Immediate Tax Deduction: When you gift/transfer assets to a DAF, you receive a tax deduction equal to the value of the assets you gifted to the DAF in that calendar year (subject to certain limits), even if you don’t distribute the funds to charity until later.
3. Administrative Ease: Because the DAF sponsoring organization handles compliance and reporting, you avoid the burden of filing annual returns and other paperwork that comes with a private foundation or CLAT.
4. Privacy: DAFs allow you to remain anonymous when making grants to charities. This can be appealing if you want to make contributions quietly, without public disclosure.
5. Low Cost: DAFs generally have lower administrative fees than private foundations.

Cons of DAFs

1. Less Control: You technically don’t own or control the assets once they’re contributed. While you can advise the sponsoring organization on where the money should go, the sponsoring organization has the final say (though it’s rare for them to refuse a donor’s recommendation if it’s a legal charity).
2. No Direct Personal Benefit: Because the assets now belong to the DAF, you and your family don’t benefit from the DAF financially aside from the upfront tax deduction—there’s no way to recoup the assets for personal use or pay yourself (or your children) a salary for charitable work as you can in a foundation.
3. Limited Legacy Building: You can name successors or advisors, but if you want a long-lasting family philanthropic entity that exists beyond your lifetime, a private foundation may be a better fit.

Private Foundations

Private foundations (often referred to as “family foundations” or just “foundations”) are independent legal entities. You and/or your family members can serve on the board and retain significant control over how the foundation’s assets are invested and distributed. Most foundations are set up as private non-operating foundations, which make grants to other charities and individuals. Some foundations are instead set up as private operating foundations, which can carry on charitable activities themselves. For purposes of this article, we’ll focus on private non-operating foundations, as they are far more common.

When Foundations Make Sense

• If you and/or your family want full control over investment decisions (or want to contribute equity in a private company) and grant-making choices (and have at least $500,000 to contribute to a foundation).
• If you and/or your family want to build a lasting philanthropic legacy that can extend for decades.
• If public visibility and branding are part of you and/or your family’s philanthropic strategy.

How Foundations Work

1. Establishing the Foundation: You file the necessary legal documents to create a nonprofit corporation or trust, then apply for tax-exempt status with the IRS.
2. Contributing Assets: Once the foundation is established, you can transfer cash, stocks, real estate, or other assets into it.
3. Foundation Governance: You (and often family members) serve as board members or trustees, deciding which charities to support, investing the foundation’s assets, and handling compliance matters.
4. Grant-making: Foundations are legally required to distribute 5% of their assets each year for charitable purposes (or overhead).
5. Reporting and Compliance: Private foundations must file annual tax returns (Form 990-PF), disclose financials, and adhere to other regulations that govern their operations, self-dealing rules, and limitations on lobbying or political contributions.

Pros of Foundations

1. Greater Control: You (and your board) decide where and when to make charitable grants, how to invest the assets, and how to handle any administrative matters that come up.
2. Grant-Making Flexibility: Foundations allow donors to support other U.S. public charities, as well as foreign charities that might not qualify as charities under U.S. law and even individuals who need help (subject to certain restrictions). DAFs can only make grants to U.S. public charities. Donors who want to support a charity in India, for example, might like the idea of setting up a private foundation that is able to do just that.
3. Legacy Building: A foundation can bear your family name and continue for generations. You can involve your children, grandchildren, and beyond in the decision-making process.
4. Prestige and Public Image: Some families like the public-facing nature of a foundation, using it as a platform to elevate certain causes.
5. Possibility of Salaries and Expenses: Board members can receive reasonable compensation for foundation-related work (if done in compliance with IRS rules).
6. Investment Flexibility: Foundations can invest in a variety of assets — stocks, bonds, private equity, etc. — and keep control over investment policies. In contrast, DAFs offer limited investment options and DAF sponsors can override a DAF donor’s investment wishes.

Cons of Foundations

1. More Complexity & Expense: Creating and running a private foundation involves legal and administrative work, ongoing compliance, and annual reporting.
2. Lower Tax Deduction Limits: The tax code sets stricter deduction limits for gifts to private foundations compared to public charities or DAFs (which are technically part of public charities).
3. Lack of Privacy: Foundations must file public tax returns (Form 990-PF) disclosing grants, expenses, and assets.
4. Potential for Complex Rules and Penalties: Foundations must navigate self-dealing rules (board members and their families can’t benefit from foundation assets) and other regulatory constraints.

Charitable Lead Annuity Trusts (CLATs)

A Charitable Lead Annuity Trust, or CLAT, can be incredibly powerful if you want to support charitable causes and leave assets to you or your heirs in a tax-efficient way. Think of a CLAT as a trust that you gift assets to once and receive a charitable deduction for the value of the gift. Then the trust pays out set amounts to charity for a specific period of time. Finally, whatever remains in the trust at the end of that term goes to your chosen beneficiaries (which can be you, your children, or another party). If those beneficiaries are your children, the amount transferred to them can avoid gift and estate taxes. Additionally Valur can help you set up a CLAT in less than 15 minutes at no cost.

When CLATs Make Sense

• If you and/or your family want to make charitable gifts while still preserving wealth for yourself or your heirs.
• If you’re looking for a way to reduce gift or estate taxes while supporting a charitable cause.
• If you have a mid- to long-term time horizon for your philanthropic planning (e.g., 10+ years).
• If you’re looking to gift $500,000 or more to charity.

How CLATs Work

1. Establish the Trust: You create a trust agreement specifying the term of the trust, the charitable beneficiaries, and the ultimate (non-charitable) beneficiaries. (With Valur, this takes less than 15 minutes.)
2. Fund the Trust: You transfer assets — usually cash — to the trust. You receive a charitable deduction equal to the value of the assets you transferred to the trust.
3. Annuity Payments to Charity: Each year, the trust pays out a fixed annuity to charity(ies) of your choice. These charities can be changed as frequently as you want.
4. Remainder to Non-Charitable Beneficiaries: After the term ends, the remaining assets in the trust are distributed to the non-charitable beneficiaries.

Pros of CLATs

1. Benefit Both Charity and Family: CLATs support charity while transferring potential asset appreciation to your heirs gift and estate tax free.
2. Potentially Significant Tax Savings: You receive an upfront charitable deduction, and any growth during the trust term can pass to your heirs with reduced gift/estate taxes.
3. Flexibility in Trust Terms: You can choose the trust’s term and annuity amount.
4. Predictable Payments for Charity: The charitable beneficiary receives a fixed amount each year, which can help the charity plan its budget and operations.

Cons of CLATs

1. Market Risk: If the trust’s investments don’t perform well, there could be little (or no) remainder left for the non-charitable remainder beneficiaries at the end of the term.
2. Compliance Requirements: CLATs have ongoing tax filings and compliance requirements, though CLAT compliance is generally simpler than private foundation compliance (and Valur takes care of this ongoing work).
3. Planning in Advance: CLATs can only be funded once, so you have to decide at the outset how much you want to put into the trust. You can’t change your mind later (though in theory you could set up a second CLAT). Also, CLAT terms are generally at least 10 years; shorter terms are possible but tend to be a bit less tax efficient.

Charitable Remainder Trusts (CRUTs)

A Charitable Remainder Trust (CRUT) is an irrevocable trust that allows the grantor to sell appreciated assets without paying taxes, reinvest the assets pre-tax, receive a charitable deduction for 10% or more of the asset value, and receive income for life or a set term of years. After the trust ends, the remaining proceeds go to a designated charity or your choice. This is one of the best ways to sell appreciated assets tax efficiently while also generating income (here’s a calculator to help you estimate the ROI). Additionally Valur can help you set up a CRUT in less than 15 minutes at no cost.

When CRUTs Make Sense

• If you have an appreciated asset you want to sell in a tax-advantaged way to create more value for you or your family.
• You don’t need liquidity immediately.

How CRUTs Work

1. Establish the Trust: You create a trust agreement specifying the term of the trust, the income beneficiaries, and the charitable remainder beneficiary. (With Valur, this takes less than 15 minutes.)
2. Fund the Trust: You transfer assets into the trust and receive a charitable deduction for ~10% of the value of assets transferred to the trust.
3. Income Payments: The trust makes regular income payments to the named beneficiaries.
4. Remainder to Charity: After the term ends or the income beneficiaries pass away, the remaining assets go to the designated charity.

Pros of CRUTs

• Tax Advantages: You receive an immediate income tax deduction for the present value of the charitable remainder.
• Avoid Capital Gains Taxes: You can sell appreciated assets and reinvest the proceeds within the trust without incurring immediate capital gains taxes.
• Generate Income: The trust provides a stream of income for you or other beneficiaries.

Cons of CRUTs

• Limited Access: You have less access to the assets once they are in the trust. You can’t buy yourself a house with the trust principal.
• Limited Benefit to Charity: If you’re focused on supporting a charity, CRUTs aren’t optimal. The charity doesn’t get anything until the end of the term, and the portion passing to charity is relatively small.

Frequently Asked Questions

1. Is a CLAT, DAF, CRUT or private foundation a better option if I want a large tax deduction?
   • Gifts to CLATs, DAFs, and private foundations are generally 100% tax deductible, but the annual deduction limits (tied to adjusted gross income) are higher for DAFs than for private foundations or CLATs. Timing wise, DAFs are the fastest to set up, though with Valur CLATs can be set up in less than a week. Private foundations may take a couple months to set up.
2. Can I convert a DAF into a private foundation later?
   • No, but you can open a private foundation in the future.
3. What happens to my CLAT if I pass away before the trust term ends?
   • The term is usually based on a number of years, not your lifetime. Assuming the CLAT’s term is a number of years, the CLAT will just keep going after your death.
4. Can I be the trustee of my CLAT?
   • Yes, in many cases you can be trustee of your own CLAT, but it’s crucial to follow all IRS guidelines and maintain the required legal formalities. Some people prefer to name an independent trustee or corporate trustee for administrative ease and to avoid certain conflicts of interest.

Conclusion

The good news is you have plenty of options, and with the right planning, you can tailor your giving strategy to align with your objectives. DAFs let you donate assets, take an immediate tax deduction, and then distribute grants to qualified charities on your own timetable — with minimal cost and headache. Private foundations provide control and visibility, making them great for families with significant resources who want a formal, long-lasting philanthropic entity. But if you want a creative solution that can genuinely benefit both your philanthropic ambitions and your heirs’ financial futures, look no further than the CLAT. By locking in a stream of payments to a charitable organization, you can secure tax advantages and still pass on any leftover trust assets — hopefully grown over time — to non-charitable beneficiaries.

About Valur

We’ve built a platform to give everyone access to the tax and wealth-building tools typically reserved for wealthy individuals with a team of accountants and lawyers. We make it simple and seamless for our customers to take advantage of these hard-to-access tax-advantaged structures. With Valur, you can build your wealth more efficiently at less than half the cost of competitors. 

From picking the best strategy to taking care of all the setup and ongoing overhead, we make things simple. The results are real: We have helped create more than $3 billion in additional wealth for our customers. If you would like to learn more, please feel free to explore our Learning Center. You can also see your potential tax savings with our online calculators or schedule a time to chat with us!