An Interview with Dr. Russell James
If you want to be challenged, surround yourself with people who are smarter than you. Russell James is one of those brilliant friends with whom I’m always positively challenged. So, I wanted to share our most recent conversation with you.
Professor Russell James III, Ph.D., J.D., CFP®, is a highly esteemed academic and expert in the field of charitable giving and financial planning. He currently holds the position of Professor and The CH Foundation Chair of Personal Financial Planning/Charitable Giving at Texas Tech University's School of Financial Planning. In addition to his academic contributions, Professor James has conducted extensive research on various aspects of charitable giving, including the nature and causes of charitable giving profiles, charitable estate planning, and the psychology behind major gift headlines. You can see a sampling of his work at his Encourage Generosity website. I asked his views about the current state of charitable giving strategies and about financial advisors’ role in philanthropic planning. His comments follow.
What do you see driving charitable giving right now?
Tax benefits remain a real driver of charitable giving. Fundraisers may love the message that donors are not motivated by tax benefits. That, however, is empirically false. We know this from national data, and we see it in the response to published material which, when it leads with tax benefits, receives much higher interest than with other headlines. The underlying truth is that tax benefits are a key driver.
The 2018 tax law may have reduced some of the tax benefits of charitable giving for the middle class, but it massively increased the benefits of charitable giving for the wealthiest. For example, it increased to 60% the income-giving limitations which don’t apply to anybody except wealthy people. The good news is that we are seeing an increase in philanthropy for the very biggest givers which is exactly what that change in tax policy was meant to incentive. It makes sense because the wealthiest have more assets and they can afford to give more. They tend to own businesses and concentrations of appreciating assets more than other people, which favors giving among the wealthy.
What are strategies and tools are you seeing advisors use most actively right now?
On one hand, it seems like to me that there’s been a broad reduction in the number of practitioners who know how to execute on strategies or tools like charitable lead trusts, charitable remainder trusts (CRTs), pooled income fund and other initiatives like those.
On the other hand, I think we're getting into an environment where the use of those approaches is going to escalate - especially the CRTs. One reason is that the peak age for doing CRTs tends to be the late 70s and the leading edge of the baby boom generation is just hitting that age range. Also, CRTs work well with inflation. One of the things that this inflationary environment does is lead to nominal appreciation of assets. That nominal appreciation of assets increases the tax burden because you’ve got capital gain, even though those assets don’t have any more purchasing power than when you bought them. A CRT can be an effective financial planning tool for high-net-worth individuals during times of high inflation because it allows for the preservation of purchasing power, offers tax advantages, enables philanthropic impact, and provides diversification and asset protection benefits.
There was a published study by a finance professor that ran 3 million Monte Carlo analyses using a 20% basis asset. And his core question was, “Is it better to have this asset in a taxable account, invest it, use it for retirement and then leave it to the kids or put it in a CRT?” The 3 million simulations proved that it is way better on average to use the CRT. Once you start stacking the value of all of those tax benefits, the value of the tax benefits actually exceed the present value of the charitable transfer.
CRTs were a powerful instrument in 1980s when people were trying to sort through and plan for high inflation and taxation challenges. So I'm fairly optimistic about this coming back into vogue as an instrument because it becomes more powerful as the environment changes.
I'm agree with you from a demographic standpoint. The baby boomers are starting to age out and increasingly they're selling their businesses and real estate assets. So, many have large, embedded capital gains and related tax burdens. What’s your view of how they’ll be impacted by changes in the capital gains tax?
I have great confidence in the ability of our Congress to not agree on anything. The estate tax exemption is set to sunset at the end of 2025. It’s likely, they’ll just let that happen which will throw many families back into having tax issues that they haven’t planned for.Who knows what the political environment is going to be, but my sense is that we're about to return to that world of estate and gift tax planning.
It seems that the more experienced advanced planners who use to have expertise in charitable giving are retiring or rolling off their book of business and there haven’t been enough legal professionals with the skills to replace them. Are you seeing the same thing?
I think that's true. We've had that market almost disappear for a generation or so. So, how do we get advisors to understand the fundamentals? There are two things I try to emphasize in in getting the core concepts in place. One is the charitable swap: understanding that when a client gives appreciated assets, they get a double tax benefit. And in fact, if your clients are not itemizing, the only tax benefit you can get is avoiding those capital gains tax, and you can make those gifts of appreciated assets without changing the portfolio. The other thing that I try to emphasize is any IRA or 401(k) qualified plan money that goes to the family results in them paying income taxes on it. Any of it that goes to charity is completely income tax free. You need to ask the charitable question. If your client has charitable interests, then a whole world of techniques opens up. It's sort of bordering on malpractice to not find out if they have those goals, because then you don't know if this whole massive range of instruments, techniques and strategies are available.
There was a very interesting study that pointed this out. It was done in the UK with people going through their normal estate planning process. 1000 people were asked the standard estate planning questions while another group of 1000 got one extra question: “Would you like to leave anything to charity?” The share of people who included charity in their estate plans more than doubled for that second group. This says that it's not that people aren't charitable, it just doesn't come to the top of the mind. And that's the role of the advisor. If the advisor doesn’t ask the question, the client is going get a plan that doesn't reflect their full intentions.
By the way, there was a third group that was asked the question a different way. It was preceded by the phrase, “Many of our clients like to leave money to charity in their will.” Instead of doubling the share of people who included gifts in their plan, it more than trippled that number and the average gift size more than doubled.
I like to start the conversation with clients about charitable giving by saying “There are three places you can leave your wealth. It can go to family. It can go to charity. It can go to the government.” Then I ask them to tell me the percentage of their estate which they would like to go to each of the three. They almost always put a percentage going to government that doesn't match the reality of their current plan. So, now we've got reason to talk about doing more sophisticated planning. Financial advisors need to ask these questions more often. Whether or not they realize it, their clients want them to ask.
For you, what thought challenges emerged from this conversation with Professor James? For me, there were many but the one that tops the list is this: Ultimately, financial advisors play a crucial role in guiding clients toward effective philanthropic planning and ensuring their plans reflect their full intentions. I challenge myself – and you, too – to increase the frequency and effectiveness of that guidance.