Although the Partnership for Philanthropic Planning (formerly the National Committee on Planned Giving), the Association for Fundraising Professionals, and others have all developed ethical codes, we have little guidance on how to best apply them to everyday situations. It would be as if our country had only the Constitution and no case law to rely upon when making legal decisions. Yet inherent in philanthropic planning are many conflicts arising from the planning process that cloud the intentions of planners - both employees of nonprofits and for-profit advisors - and that at times confuse donors. As decisions made today can have consequences years, even decades, from now, we, who are most involved in the planning process, must at the outset be prepared to think through as many issues as possible in the complex world of philanthropic planning.
Acting ethically requires more than reacting on a gut level. In fact, reacting only on a gut level - no matter how “right” we may think it is - is actually irresponsible, and the result is frequently the opposite of ethics-based decision-making. While each person’s own credo of right and wrong plays a vital role in making ethical decisions, all too often dilemmas arise where more than one decision or course of action can be right as well as suspect. The key is to make difficult decisions with an understanding of why we make them, and then, to the best of our ability, to communicate our reasons.
Each month, the Partnership for Philanthropic Planning of Greater Philadelphia, in cooperation with the National Capital Gift Planning Council, will post real questions from real people answered by Doug White, a national leader in the philanthropic community. All identities, both of people and places, will be kept confidential. PPPGP members have the ability to share their comments on each monthly post since no one person has all of the answers. Members also have full access to the archive which includes both the posted dilemma and resolution, plus any comments made by members.
Latest Dilemma & Resolution (posted 02/21/2011)
Ethics of Discounting
I know we need to discount gifts to calculate remainder values; but, from what I can tell, it’s not black and white, even though I always thought the IRS method was an absolute valuation process. When we aren’t valuing the present value of a unitrust, annuity trust, or gift annuity, however, how should we discount expectancies? My financial director says we should use a high discount rate because that makes the present value conservative. I understand that an amount due in the future must be discounted but I always thought it should be connected to inflation. How should we discount future values?
Unfortunately, most people think that when a mathematical process is involved, if the formula is correct, the result is certain. In fact, most of the time the opposite is the case. While it may seem difficult to discount a value by, say, 10 percent a year for five years, that process is actually quite simple. We can all agree on the number that emerges – 59 percent. But who’s to say everybody agrees on the factors – in this case, 10 percent and five years? The IRS’s calculation takes into account actuarial tables for one of those factors – life expectancy – and no one seems to have much problem with those assumptions, but what about the discount rate? (Ever wonder about what’s being discounted, especially as the deduction is higher when the discount rate is higher? Short answer: for annuities, the income value; unitrusts and pooled income funds work slightly differently.)
The bone of contention lies in the discount rate. The IRS dictates the rate we use for split-interest gifts, but nothing guides us when discounting values for other purposes. Should we discount at the rate of inflation (which has been rather low lately)? Or a charity’s actual increase in spending (which is often higher because the cost of programs has traditionally been higher than inflation)? Or what about something called “opportunity cost” (the amount the charity does not earn because the amount is not being invested, often the highest rate of the three)? Deciding the rate to discount an expectancy is fraught with subjectivity, and, if the result steers anyone into analyzing the success of a planned giving program – and certainly if salaries become dependent on it – the process is very much ethics-based.
I once had to deal with a finance person who insisted that the entire planned gift expectancy portfolio be discounted by the average market growth over the past five years. This was in the mid-1990s, when the stock markets were soaring. And you are right: the higher the discount rate, the lower the resulting present value. The difference between using the inflation rate and the opportunity cost rate was a whopping (and disheartening) $50 million. That is, the finance person claimed that the planned giving effort resulted in $50 million less than everyone thought. And this was already a fairly sophisticated group.
That story ended with the charity using a rate something above inflation and below its annual cost rise. The staff documented why and how the rate would be determined, which is most of the battle when it comes to making subjective decisions. It also mattered – to the trustees if not to the finance person – that using the opportunity cost made no sense because the money was never available to invest in the first place. Some finance officers think that a deferred gift is an option, that the donor merely chooses not to give the whole amount outright, that if fundraisers were really doing their job donors would just give it all at once, now.
But that can go the other way, too. If you don’t like 59 cents on the dollar, just use a discount rate of five percent: your work is all of a sudden worth 77 cents.
Interested in sharing your thoughts? If you are a member, log in at the left and comment on this dilemma and resolution. Note the member name will automatically be listed with each comment. If you are not yet a member, click here to learn how you can join and begin enjoying the many benefits of membership.
This column appears courtesy of the National Capital Gift Planning Council and author Doug White, a nationally recognized speaker and writer on the subject of gift planning and ethics. To learn more about Doug and how to contact him, please click here.