By Kathleen Nemetz, MBA, CFP
Learn more about Kathleen on NerdWallet’s Ask an Advisor
It’s the giving season again, a time when many investors explore whether their investments can also grow for the greater good. If you’re thinking about how to nurture your nest egg and further your desire to do good, you may want to consider certain types of investments and strategies.
Here are two basic methods for putting your money to work in ways that benefit the world: tailoring your investments to match your beliefs and using tax-friendly charitable giving strategies.
Socially responsible investing
Investing that takes into account both financial returns and social impact is known as socially responsible investing. Other monikers might also be used, such as sustainable and responsible investing, green investing or socially conscious investing. Generally speaking, the idea is to make a positive difference in the world by directing capital into socially beneficial areas of the economy. Depending on your own beliefs and values, you may favor investments that focus on protecting the environment, for example, or that consider fair-trade practices a requirement for investing. Still other investments may be guided by religious values.
Applying criteria based on such social goals, investors can put their money to work in a variety of ways. Some may prefer to buy individual stocks and bonds for these types of investments. For example, they may choose to invest in companies that donate a large amount of cash or a percentage of their profits to the community or to charities. Or investors may prefer to buy municipal bonds to build or maintain schools, thus supporting educational goals. Other investors may want more diversification, focusing on the dozens of publicly traded mutual funds that ascribe to various principles to filter investments, rather than looking exclusively at performance.
Whatever the criteria, the performance of the underlying investments can and should still be considered. Socially responsible mutual funds have largely performed well this year, according to Bloomberg’s ranking of sustainable and responsible funds. But beyond performance and social impact, you must also consider the tax consequences and how these investments fit into your overall portfolio and strategy. For instance, holding a mutual fund may mean you will experience taxable distributions of capital gains when positions are traded within the fund, so keep this in mind when choosing a fund over an individual stock or exchange-traded fund.
Tax-friendly tools for giving
Investors in higher tax brackets may wish to mix their objectives of lowering their tax bills and investing for good through the use of a donor-advised fund. When you donate to such funds, you receive a tax deduction, your investment grows tax-free and the investment income can be distributed to nonprofit organizations or charities per your recommendations. These funds can also be set up with screening criteria for the investments used in the portfolio.
Community foundations, which are larger nonprofits that manage endowment accounts for multiple charities in their region, offer a turn-key way to do this type of giving, usually with low or no minimums for the initial gifts. Donors direct their investments to specific types of funds offered by the foundation (for example, scholarship funds). These investments cannot benefit the donor or any private interest, and periodic distributions must benefit 501 (c)(3) nonprofit entities only.
If the donor wants to choose other investments, another option to explore is the creation of a trust. Depending on what type of trust is created, the principal would remain under control of the donors or be released under the terms of the trust. If the legacy or income stream planned is substantial, then it may make sense to work with an estate-planning attorney to set up a charitable lead or remainder trust. Both are irrevocable trusts, meaning the grantor cannot change the provisions once the trust is created.
With a charitable lead trust, the income from the invested capital is earmarked to go to a nonprofit in exchange for a tax write-off. This arrangement expires after a period of time when the control of assets reverts back to the donor or the donor’s estate. With a charitable remainder trust, the principal may be invested for the benefit of a living person or persons, but upon the death of the donor or after a defined period of time, the invested principal passes as a gift to a designated charity. Gifting monies to such trusts results in a tax break, subject to specific Internal Revenue Service formulas. A qualified tax expert and an attorney should be consulted in setting up these types of accounts.
Finally, donors wishing to have substantial control over investments and gifts may consider a family foundation. However, this form of giving may also be the most expensive, as private foundations necessitate the creation of a nonprofit entity, which must follow complex rules, pay excise taxes on investment income and provide yearly tax reporting to the IRS. Donors opting for this form usually prefer to set up a private, nonoperating foundation that makes gifts to other 501 (c)(3) charities rather than providing actual services. Qualified attorneys or tax experts can help navigate tax rules dictating how these foundations are to be created and managed. They can also advise donors on the resulting tax breaks available for the initial and ongoing contributions to fund the private foundation’s gifts and activities.
Whether it’s through socially responsible investments or tax-friendly donation vehicles, there are several ways to put your capital to work for the social and charitable causes you seek to support. As you get into the giving spirit this year, make sure you take a deeper look at the ways your money can make a difference in the world, while facilitating smart financial moves that support your personal goals. Talk to an advisor to help make the most of your contributions.
Kathleen Nemetz is a certified financial planner in San Rafael, California.
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