Wealthy families can give well to live well ... together

As the adage goes, Money can't buy happiness.

So it's no wonder that very wealthy families, like all families, can still have very stormy relations. A neglected son blames his pampered sister. Spoiled kids resent their overbearing parents. If money isn't the root of all evil, it can often fuel a whole lot of conflict and anxiety in wealthy families.

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One of the best ways to get any family working and living well with each other is to have them do good things for others together. In the case of high-net-worth families, philanthropy is not only about getting a really nice tax deduction—and it can be really nice—but also about fostering communication between family members and engaging the next generation in matters of importance to the entire family.

"The No. 1 way to work with children and transmit family values to them is through philanthropic activities," said Daisy Medici, managing director of governance and education at GenSpring Family Offices, which advises ultra-high-net-worth families.

There are essentially three options for families who want to engage in philanthropy: Give directly to charitable organizations, create a foundation to manage the activity, or use donor-advised funds—typically managed by large financial institutions—to manage the process. How to structure the activities depends foremost on what a family's objective is with their giving.

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If the object is simply to support causes that the family values and to get the tax deduction for contributions, a direct-giving program may be the easy solution.

Direct donations of cash to charitable organizations are fully tax-deductible up to 50 percent of the donor's adjusted gross income, or AGI. For someone with a high annual income, the tax savings can be huge.

However, for high-net-worth families giving away large sums of money annually, the job of managing donations and keeping records can very quickly become a major task. An increasingly popular solution is to use donor-advised funds (DAF) to handle all the administration and logistics of philanthropy.

Funds perform due diligence on charitable organizations and handle all the compliance work for donors. Contributions to such funds are also deductible up to 50 percent of the donor's AGI. That's a significantly higher threshold than the 30 percent allowable for philanthropy conducted through private foundations.

According to the 2013 Donor-Advised Fund Report from the National Philanthropic Trust, the number of DAFs in the U.S. has increased to more than 200,000, up from 40,000, since the year 2000. Contributions to the funds in 2012—the latest year data is available—were up 35 percent, to $13.7 billion, and assets in the funds increased 19 percent, to $45 billion.

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"The funds offer better tax-deductibility and ease of administration," said Benetta Jenson, a wealth advisor for J.P. Morgan Private Bank, which manages donor-advised funds. "We've seen a huge uptick in demand for them."

The rub with donor-advised funds, however, is that the funds technically make the decisions about where the money goes. But for all intents and purposes, the donors do still call the shots. "The only time a fund is likely to deny a recommendation is when the charitable organization doesn't quality for tax-exempt status," Jenson said. "It's to protect the donors."

While families can and do get members actively involved in determining where DAFs will distribute money, private foundations give families more control over all stages of the charitable process. They allow families to have members more deeply engaged in the giving process, and they can very often become a major cohesive force for a family.

The management of foundations is a lot more complicated and costly than giving through DAFs. For one thing, foundations have to file an annual tax return—a 990-PF—covering all the funds controlled by the foundation.

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There are also a lot more rules to follow regarding conflicts of interest and self-dealing, compensation of family members and payout of foundation assets.

"The IRS looks at 990-PFs very closely," said Jim Brennan, a senior wealth advisor with GenSpring. He said a rule of thumb in the industry is that you need at least $1 million in charitable assets to make it worth setting up a foundation. "There are a lot of different operating aspects to foundations, and it's important not to run afoul of the rules."

Foundations may cost more and involve a lot more work than other charitable options, but that is often part of the attraction for families. They can be great training grounds for NextGen members of family businesses.

"Family business owners often look to charitable vehicles to help educate NextGen members about different ideas, such as stewardship, legacy, investment management and the family business," said Jenson at J.P. Morgan Private Bank.

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The key to making it work is to give younger members of the family real power over how the foundation functions. "It only works when parents let children decide what's important to them, too," said Medici at GenSpring.

"It's a mistake when parents ignore what causes their children are passionate about. That's when they get connected," she said.

The causes they embrace are likely to be different from the ballet, the libraries and the hospitals that their parents have traditionally supported, but unless younger family members are given some freedom, they aren't likely to enjoy the experience.

"When senior family members go through the motions of getting kids involved and then force decisions upon them, there can be some bad breakdowns," Medici said.

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The more typical experience is that philanthropy brings families together and opens up channels of communication and cooperation that they wouldn't otherwise have, Medici explained.

"Some of the best discussions we have with families are around the values of giving," she said.

—By Andrew Osterland, special to CNBC.com.