In addition to retail, institutional, and business clients, financial professionals can also open accounts for estates, foundations, and charities. This chapter covers each of these client types.
When a person dies, their assets often become part of their estate. If there isn’t a contractual arrangement tied to the asset (for example, a transfer on death designation or a trust agreement), the asset generally becomes estate property at death. The estate then goes through probate court, where the court oversees the process of validating authority and settling the estate.
A will is a legal document that directs how a person’s assets should be distributed to beneficiaries after death. A person dies either:
When a valid will exists, it names an executor. The executor is responsible for paying the decedent’s debts and distributing remaining assets to beneficiaries. After death, the executor presents the will to the probate court. If the court accepts the will as valid, it issues letters testamentary, which legally confirm the executor’s authority. The executor then pays the decedent’s debts and distributes the remaining assets according to the will.
If no will exists, a family member or friend typically petitions the probate court to be appointed administrator of the estate. The administrator performs a similar function to an executor, but without a will to direct distributions. In that situation, the probate court often helps determine how assets should be distributed.
Estate accounts are fiduciary accounts, so they’re subject to fiduciary-specific rules and regulations. In practice, this means the executor or administrator must put the beneficiaries’ interests ahead of their own.
Estate assets are often distributed within a few months. Because of that shorter time horizon, the executor or administrator typically isn’t investing for long-term goals.
Combining investing with charitable giving has become increasingly common. Investing for charitable purposes often involves impact investing, also called socially responsible investing. As quoted by a Fidelity Investments charitable giving site:
Impact investing is the act of purposefully making investments that help achieve certain social and environmental benefits while generating financial returns. It’s a broad term that refers to everything from investing in companies with an explicit mission aligned with your values to avoid investing in companies that do not meet those criteria.
Impact investing is common in charitable portfolios because the investments can be chosen to match the donor’s goals. For example, if the goal is to support charities focused on climate change, investing in green energy companies may align better than investing in oil companies.
There are three typical ways to donate assets or securities to charitable causes:
With a direct donation, an investor gives assets or securities straight to the charity of their choice. Donations are typically tax-deductible, which can reduce the donor’s taxes.
In many cases, donating securities can be more tax-efficient than donating cash. For example, suppose an investor buys $80,000 of stock that later rises to $100,000 and the investor wants to donate $100,000.
Donating a security is generally most beneficial when the donor has an unrealized gain (a gain on a security that hasn’t been sold yet). If the investor has an unrealized capital loss on a position they want to donate, it’s often better to sell the security first and donate cash. That approach can create a tax-deductible capital loss on the sale, in addition to the tax deduction for the charitable donation.
Regardless of the method, charitable giving typically provides some form of tax relief. Many investors also use charitable giving as part of estate planning. For example, Warren Buffet has pledged to give away 99% of his wealth to philanthropic causes. In general, the more that’s given to charity, the less an individual or estate may be subject to taxation.
A private (non-governmental) foundation is an organization formed for the sole purpose of charitable giving. A well-known example is the Bill and Melinda Gates Foundation. To fund their foundation, Bill and Melinda Gates donated a significant portion of their wealth (they’ve pledged over $100 billion in funding to the organization).
This structure is typical: private foundations are funded by their founders rather than by public fundraising. Investors who want to give this way generally establish their own foundations. A foundation doesn’t need to be extremely large; roughly 66% of private foundations maintain less than $1 million in assets.
Once funded, a private foundation is managed by the Foundation Board (similar to a corporation’s Board of Directors). The Board’s role is to manage foundation assets, identify charitable giving opportunities, and make donations when appropriate.
Like direct charitable contributions, assets used to fund private foundations are generally tax-deductible.
An increasingly popular way to donate to charities is through donor-advised funds (DAFs). Instead of donating directly to charities or creating a private foundation, investors establish “giving accounts” at financial institutions. Companies like Fidelity and Charles Schwab offer these accounts.
Investors can contribute a wide range of assets to giving accounts, including cash, securities, and even cryptocurrencies. After the contribution, the donor (or their adviser) manages the assets. If the account value grows over time, the donor can later recommend grants to eligible charities. When the donor requests a donation, the firm that holds custody of the giving account distributes assets to the charity.
Charities generally must be 501©(3) public charities to be eligible for DAF contributions. This designation is provided by the Internal Revenue Service (IRS), which recognizes the organization as a legitimate charity. There are two types of 501©(3) organizations:
A key distinction is how they’re funded. Private foundations are funded internally by their founders, while public charities are funded by public donations from non-affiliated individuals and organizations.
Like direct donations and contributions to private foundations, DAF contributions are tax-deductible to the donor.
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