If you are nearing retirement, you may have built up a strong credit rating. Once we pay off mortgages and finish helping the kids get through post-secondary, many of us are finally able to save money. Approximately 48 % of Canadians over 55 years old own a mortgage-free home.[i]
Since we don't need to borrow money, now the banks would love to lend us some. That's an ironic switch from our early relationship with the banks. When we needed money, they were stingy. Go figure!
Meanwhile, many charities lack money. Charities know what to do to solve our collective issues but can't always do their very best due to financial realities. If Canadians could finance them sustainably and to the level needed, many serious and significant problems could be much more adequately addressed.
What if we could use the bank's willingness to lend us money for the benefit of charity for today and the future? What if it costs a donor almost nothing to do this? Wouldn't you want to help?
This blog will show how charities could benefit from your good credit rating.
The Idea and Potential Opportunity
First, let me say, this is an early-stage idea, and questions abound on how to do this. Legal and tax issues come to mind. But please temporarily suspend your concerns to allow me to present the idea:
People with good credit borrow and lend that same money at market rates back to a "fund generator" for twenty years. The fund generator is a business that invests the contributions lent to it in the stock market and uses earnings from those investments to pay the lender their due interest.
The growth money remaining after paying interest is paid to the lender's charity or charities of choice in two portions: one part goes immediately to charity while the other part remains invested for future planned donations for the decades and centuries to follow.
Let's illustrate this with a specific example. Scale the numbers up or down to suit your comfort level.
A donor/lender with available credit room borrows $100K from the bank at 4.7% interest. Investments generate 8.3% of earnings, of which 4.7% is used to pay interest. Charities get a portion of the annual growth. If we assume charities get 50%, the remaining 50% is used to augment the investment funds.
After twenty years, the donors have had no borrowing costs, but the charity has received $53K, and the funds' generator has $25K remaining to grow further.
If donations annually could be permitted as a tax benefit for the lender, after paying taxes on withdrawn earnings, the net twenty-year tax savings is $5.5K. However as this would be a contracted arrangement (to ensure performance) and could not be considered a voluntary gift, the donor gift is most likely not eligible for a tax deduction.
After twenty years, the borrowed principle is paid back. At 150 years, the future gets $13 Million every 25 years.
This approach can be arranged at no cost to the lender other than a reduced borrowing capability. But if the lender does not need to borrow, which is our assumed case, this reduction is a moot point!
The benefits could be staggering, both now and in future. If $100 Million were to be raised, the annual gift to charities could be $2.5 M per year for the first twenty years and higher. Furthermore, at the eventual 150-year mark, the charities would begin receiving $13 Billion every 25 years, on top of an approximate cumulative $3 Billion received in the preceding twenty-five-year intervals.
These fantastic numbers encourage me to consider this worth a closer look.
Risks
Two main risks are faced, investment risk and repayment ability.
Repayment need not be an issue. At any point, the donor or their estate can cash out the account and pay back their loan with the proceeds. The risk from early redemption is zero to the estate or bank. The gifts to charity and future funds are reduced depending on how soon the loan is redeemed.
Per our above example, if the loan is recalled after ten years, the charity ends up with $21K (vs $53K), and the future gets $5 Million (vs $13M) every 25 years. Still, this is a lot to get/ give for no actual cost to the donor.
Investment risk is the main issue. What happens if the stock market experiences a significant downturn? Here we need to look beyond average returns to the specific year-by-year results.
I examined this risk by doing a simulation 150 times using the year-over-year outcomes of the Dow Jones and S&P averaged together and then randomly applied for a set of assumed periods before redemption of 5,10, 15 and 20 years.
The details of this study will be the subject of next month's blog. But for now, here are the rather excellent results:
Years before withdrawal | 5 | 10 | 15 | 20 |
Instances below $Loan Value | 11.1% | 3% | 0% | 0% |
Ave % Value if below $Loan | 90% | 97% | more than 100% | more than 100% |
Median % Value | 159% | 242% | 371% | 525% |
The above table assumes 4.7% is used to pay interest and these results are net of those payments.
The way to read this table is, for example, for the 10-year column:
the loan is redeemed by the lending donor in year 10
the Fund Generator has a 3% chance that the lender's account has less that the original loan, due to market gyrations. Stated another way, the Fund Generator has a 97% chance of having more than the original loan on hand, even after paying annual interest.
if the Fund Generator result is less than the full loan amount, the average value is 97% of that full value loan. So only a 3% reduction on average would apply to the redemption amount.
after ten years the Fund Generator has a Median Value of 242% of the loaned money. In other words, in year ten, 50 % of the loans now have more than 242%, and 50% have less than 242% of the original loan value on hand for repayments. This means after paying back the loan, at the median result level, the charity fund can continue with 142% (242% subtract 100% for the loan) of the loan value as seed funding.
While not shown, average values for each year were approximately 10% larger than the median values
The chance that the fund repayment value would be lower after deducting the annual 4.7% interest varies with how long you stay with the program. The longer you stay in, the less the risk of not getting your original capital back. Ideally, this would be positioned as a 15-year minimum length plan at full interest rates, and perhaps a lower rate if earlier redemption options are preferred.
Considering the stellar results for the median of the five and ten-year early redemptions, these losses could be covered by the pooled investments once the fund reaches a sustainable size.
In the long run, offering guaranteed full face value on early redemption may be possible under all market conditions. In the short run, contributors would have to be willing to accept a possible small loss of capital.
Pros and Cons
Pro
· Lenders can donate without any cost at reasonably low risk.
· The government saves on tax deductions on donations
· Charities could raise sustainable and increasing funds
Con
· No tax deduction for money going to charity
· Somewhat complicated to explain and implement
Conclusion:
Using available credit could be an excellent additional way to give to charities now and in the future. It seems worthwhile to investigate this possible funding approach further.
What do you think? Please write me at Cam@FutureLegacies.ca with your comments.
Footnotes:
[i] Per The Daily — Housing in Canada: Key results from the 2016 Census (statcan.gc.ca) 76% over age 55 have a home, and of those 37% have a mortgage. So 48% of those over 55 are mortgage free (76% times (100% less 37%)
Photo by Towfiqu barbhuiya on Unsplash