This month's challenge is to determine which approach most benefits charitable funding.
Option 1 is where a donor leaves a 'Normal' legacy gift, or
Option 2 is where a donor leaves a combination of 'Normal' and 'Growth Fund' gifts.
As we will show, the answer depends on the decision maker's time horizon. Our study uses a long time horizon because the chronic shortage of funds for social good has been and is projected to be extended. And, after we pass away, infinite time awaits.
Both options generate annual spending on charitable services, which we can represent over the study period via the cumulative spending by the charities. We assume an equal annual spend of 5% applies to either option on any funds held by the charity, charitable foundation, or Donor Advised Fund (DAF).
Note that the charity will not hold the Growth portion until a payout is made from the Growth fund to the charity. These payouts are planned to be once a generation, every 25 years, and to be half of the Growth fund balance at each 25th-anniversary date.
Please! Leave a legacy
Leaving a legacy gift, per either option one or two, is a great thing to do. You enjoy your wealth until you pass away, and your gift to charity saves estate taxes. Learn more at WillPower.ca.
Legacy gifts can be immediately used by the charity or spread perpetually over time by spending 5% per year. The spend rate of 5% is the new level for the 2023 Disbursement Quota (DQ) annual minimum. The DQ rate applies to investment assets not used to provide charitable services held by registered charities and is the legally required minimum annual expenditure.
We will compare equivalent cumulative DQs for Options 1 and 2 for this comparison.
The first graph below shows a 300-year comparison. With the 'normal' Option 1, the blue line, the fund must spend the DQ annually, which applies to the entire gift. The funds held, therefore, may only grow (excluding possible new donations) if return rates exceed the DQ rate. All funds held in Option 1 are within charities, and thus the DQ applies to all Option 1 investment income.
Growth Option 2, shown with an orange line, rises exponentially compared to Option 1. The growth portion of Option 2 is held outside the charities in a For-Profit enterprise and thus is not subject to the DQ effectively increasing the growth rate on the growth portion vs the normal charity portion. Even though the size of the growth portion is relatively small at first (5% of the gift) compared to the normal portion (95% of the gift), given enough time, the growth portion eventually grows to enormous impact.
The net result over a 300-year span positions charities under Growth Option 2 with an excellent funding situation and still more growth to come.
The early years' trade-off
The above graph shows Cumulative DQ benefits are equivalent in Year 103. Option 2 is less attractive in the early years. Funds held by the for-profit per Growth Option 2 do not add to the DQ annually until payouts begin in Year 25. Funds available via teh DQ for charities are higher for the early years with Option 1.
Option 1 may be a better choice if your timeline is less than 100 years. However, by offering donors Option 2, some donors may be so inspired they will give their 5% on top of the 100% legacy gift. Developing ways to gather growth funds well before the legacy gift holds promise.
It is all about balance. Option 2 must significantly emphasize the money as being for now vs the future. Giving 95% now and merely 5% for the future is perfect. Higher future portions simply mean lower first-century impact. Using a 95% level, almost all the money is in the first century, with tremendous upside after the first century.
A 100-year view shows details of the impact in the following graph:
Conclusion
These two graphs show that after 300 years, tremendous and accelerating charitable funds can be available. However, these Option 2 returns came at a nominal cost of up to 3.5% less cumulative DQ in the first 100 years.
Selecting your best alternative depends on your time horizon. Less than 100 years, Option 1, more than 100 years, Option 2. With Option 2, society may have reason to hope for an end to the chronic funding shortages. A full discussion of why donors should or should not consider making a Ben's Way growth gift is discussed here.
More details about our comparison
Option 1 is the current status quo approach available today. We assume a donor in Option 1 gives their perpetual legacy gift to foundations for specific causes or uses a personal Donor Advised Fund (DAF) to enable perpetual donations across various charities.
Option 2 Growth Option 2 is called a 'Ben's Way' gift, so named after Benjamin Franklin, the first person to use the power of long-term compounding of investments. Such an option doesn't exist in the investment marketplace for donors to select today. The vision driving these articles is that being able to make Ben's Way gifts definitely should exist now.
Franklin gave about $150 K in today's dollars to start a microlending company for artisans of his day. His business design provided loans in support of young apprenticed artisans to start a business and prosper. This program was an early form of social impact investing.
Franklin requested the lending company wind up after 200 years, with the proceeds going as gifts to Boston, Philadelphia and their respective states. Earnings from the lending business compounded for two centuries to a final balance in the millions!
A Ben's Way gift would mimic Ben Franklin's approach by investing long-term in compounding the funds. Unlike Franklin's plan, our growth would not stop at any particular year, but instead, we propose that it level off when the fund for each donor reaches $1 Billion in today's dollars. In this way, all donors eventually contribute equally, with some gifts taking longer than others to reach the billion-dollar level.
Once a donor's fund reaches $1 B, a 4% ($40 Million) portion starts transferring annually from the Ben's Way for-profit funds generator into the charity side via the donor's DAF or selected charitable foundations.
Since Ben's Way extends deep into the future many thoughtful questions arise. A fairly complete list of issues has been discussed in an earlier article here.
Balancing the portion for now vs the future is crucial. Importantly, Option 2 emphasizes most of the legacy gift is for immediate use, as 95% is for today and only 5% is for the future. This ensures most of the legacy gift is immediately available to aid charities, with only a small portion set aside for future gifts.
If we set the growth portion to be larger, then the first-century charity funds go down, and the long-term growth portion gets larger faster. This higher growth portion affects the first century and is not worth the increased early negative impact.
Option 2 Growth projections
With our intended plan, every donor's fund will eventually reach the $1 Billion level. The following table suggests when:
Overall 100% gift | Ben's Way 5% | After-tax Ben's Way* | Multiple to grow After Tax Ben's Way gift to reach $1 B | Estimated Years to $1 B |
$10 M | $500 K | $125 K | 8,000 times | 400 years |
$1 M | $50 K | $12.5 K | 80,000 times | 500 years |
$100 K | $5 K | $1.25 K | 800,000 times | 600 years |
Along the way to $1 Billion
Since half the Growth Fund transfers to the charitable side every 25 years, the total charitable funds subject to DQ accumulate. These accumulating funds are significant. At every 25th-year payout, the cumulative gifts approximately equal the new payout.
For example, if the payout in year 100 is $10 K, the accumulated payouts from Year 25 + 50 + 75 equals about $10 K.
So in the year when we hit $1 B in our personal growth fund, we would have already given $1 B! After reaching the $1 B level, switching to giving $40 Million every year curtails further real dollar growth.
Leave the world a better place.
Today when we give over our dollars to charity, we get a receipt for a non-refundable tax credit, effectively reducing the cost to the donor by half. This effectively is a donation matching program offered by the government to encourage donations.
If donors find the government's matching attractive, then they should prefer the Option 2 growth legacy, which offers ever-increasing matching levels that continuously and significantly grow across the centuries that lie ahead.
Our generation's growth legacy in 100 years will serve the grandchildren of our grandchildren, one heartbeat away from our direct connection. Their descendants will increasingly reap the benefit of our efforts today. However, only we are in a position to set this up for their benefit.
Which option would you want to leave as your legacy?
Photo by Elena Mozhvilo on Unsplash
* The table's column 'After-tax Ben's Way' gifts are calculated as follows (using the first line as the example): Ben's Way 5% of $10 M gift = $500 K. From this $ 500 K, we subtract 50% to replace the tax receipt not issued ($500 K x 50%) = $250 K. In this way, the donor effectively gets an equivalent to the government tax break. From this $250 K, we subtract 50% income tax on the income the For-Profit Ben's Way fund generator receives ($250 K x 50%) = $ 125 K. Note that tax strategies are being investigated. Still, using this gift rate makes the results the most conservative possible for comparison.
Comments