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Mutual Funds: A Less Taxing Choice

The stock market may be sickly, but plenty of Ken Richard's clients face painful capital gains tax bills. A registered financial consultant at Kara Financial Services in St. Paul, Minn., Richard advises longtime employees of such Minnesota blue-chips as 3M, St. Jude Medical and Honeywell. These clients purchased sizable stakes in their companies years ago, and since then share prices have more than

The stock market may be sickly, but plenty of Ken Richard's clients face painful capital gains tax bills. A registered financial consultant at Kara Financial Services in St. Paul, Minn., Richard advises longtime employees of such Minnesota blue-chips as 3M, St. Jude Medical and Honeywell. These clients purchased sizable stakes in their companies years ago, and since then share prices have more than doubled. One 3M veteran, who must now sell shares to fund retirement, faces capital gains of almost $100 a share. While there is no way to make the tax problem vanish entirely, Richard helps limit the damage by recommending charitable gift funds. “These are wonderful tools for clients to make donations and enjoy significant tax advantages,” says Richard.

Charitable gift funds are offered by about a dozen companies, including Calvert, Eaton Vance, T. Rowe Price, Fidelity and Vanguard. The funds hold total assets of about $10 billion, according to the Chronicle of Philanthropy. Each fund is structured as a trust — not a mutual fund. Investors deposit money into the trust and receive a deduction. While in the trust, the money can be invested in a variety of options, typically including money market funds, as well as stock and bond funds. The funds are targeted at upper middle class people as well as investors from the lower ranks of the wealthy. The truly wealthy may prefer to open their own private foundations.

In a typical transaction, you donate stock to the fund. You deduct the full amount of the donation. Once the money has been put into a trust, the client cannot take it back or receive income from a typical gift fund. The money can sit in the charitable fund indefinitely, or it can be used for immediate donations. Investors who want to receive income from their donations can use a charitable remainder trust or one of the special funds operated by Eaton Vance and other companies that resemble charitable remainder trusts.

If the client donates appreciated stock, he can deduct the full value of the shares. The client does not owe any capital gains taxes. Say the client bought stock at $20 and donated the shares after they appreciated to $120. The client would deduct the full $120. He would not owe any capital gains taxes on the stock, and the charity would not owe any capital gains taxes. The tax bill would simply vanish.

The only negative feature may be that the funds all carry fees. To make a donation, the client must pay an annual administrative fee as well as the management fees on the money markets or other investment vehicles that the trusts use. If the client makes donations directly, he need not pay any fees. But many churches and small institutions aren't equipped to accept donations of stock directly. So donors might be forced to sell the stock first, pay the capital gains taxes and then give cash to the institution. Direct donations can get messy and that means more paperwork for you.

One of the big advantages of a charitable fund is convenience. Accounts are easy to set up, and the companies provide paperwork needed to document deductions. Some charitable funds make an effort to be flexible about the donations they accept. Besides taking shares of public companies, Fidelity Charitable Gift Fund often accepts private stock, and sometimes even real estate. “Some of our donors are in the process of selling private companies, and they're looking for ways to manage their capital gains tax exposure,” says Cynthia Egan, president of Fidelity's charitable program.

Wealthy families may prefer setting up their own foundations instead of using a charitable fund. Foundations do have certain advantages. For example, the family can put relatives on the foundation's payroll. But foundations can run up big bills for accountants and lawyers. A charitable gift fund provides many of the advantages of a foundation with none of the startup costs.

Funds may be particularly suitable for clients who plan to make a series of regular contributions. Say the donor gives $2,000 every year to a church. To obtain the tax benefits sooner, the investor can put $10,000 into a charitable fund now, and deduct the entire amount right away. Then in each of the next five years, the donor can instruct the fund to send a check to the church. The strategy is effective for someone who will receive a big bonus or other windfall this year and wants to take a big deduction now. If a client isn't sure where to donate, he can still put money into the fund and take a deduction immediately. Then the giver can take time to research charities, making donations whenever he is inclined.

Charitable gift funds also require a bit of philanthropy on the part of brokers: They typically pay advisors smaller fees than those offered by conventional mutual funds. Eaton Vance, which provides maximum front-end loads of 5.75 percent on conventional funds, pays advisors a 1 percent front-end sales commission for deposits into the charitable fund. Calvert, another load company, pays only an annual trailing fee of 0.25 percent. Still, the charitable funds can be important tools for maintaining good relations with clients. “Once a year you can call your client to talk about something very positive, gift giving,” says Jeff Beale, president of Eaton Vance's charitable program.

At many companies, clients can manage accounts online, instructing funds to issue checks. Clients can also name advisors as their agents. Then the client can simply call the advisor and ask him to inform the fund of which charities will receive checks and of what amounts.

For clients who want to make donations and still receive some current income, Eaton Vance offers a special fund that resembles a charitable gift trust. In a traditional charitable gift trust, the donor gives assets that are invested in a trust. The donor receives some taxable income each year. On his death — or at the end of a specified period, such as 10 years — all the assets go to a charity. Because the donor receives some income, he can only deduct part of the donation. The Eaton Vance fund can accomplish what a trust does — but at reduced costs, because there are no upfront legal expenses.

Richard recently used an Eaton Vance charitable trust for a client who wanted to enjoy the tax benefits of a donation while saving for college tuition bills. The transaction started with a donation of $50,000 of appreciated stock into a charitable fund. Because the donor will receive income, he was only able to deduct $12,000. (The exact amount of the deduction is regulated by an IRS table that is based partly on the age of the donor.) From the fund — which invests mainly in bonds — the donor now receives a taxable annual income of about 7 percent. If the client stopped at that point, he would have a nifty strategy that sheltered his assets from capital gains taxes. But Richard has gone one step further. He has taken the income from the trust and deposited it into a 529 account, a tax-sheltered vehicle, which will pay for the college expenses of the client's grandson.

For some donors, the most important advantage of the funds is that they offer an opportunity to train heirs. Parents can set up an account and turn it over to children, teaching the younger generation about the importance of developing a regular program for charity — and tax planning.

Charitable Gift Funds

Enjoy Significant Tax Advantages

Most charitable gift funds are set up as trusts, not mutual funds.

They charge investors annual administrative fees that cover the costs of running the trusts. While some funds are no-loads, others pay advisors sales commissions or annual fees. Here are some of the larger, better-known funds.

Fund Minimum Investment Maximum Administrative Fee Maximum Fee For Advisor
Calvert Giving Fund $5,000 1% 0.15% a year
Eaton Vance 10,000 1% 1% sales commission
Charitable Gift
Fidelity Gift Trust 10,000 1% 0.25% a year
T. Rowe Price Program for Charitable Giving 10,000 0.50% none
Vanguard Charitable Endowment 25,000 0.45% none
Source: Company data
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