Charitable gift annuity

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Template:Charitable Giving Sidebar Template:Annuities Sidebar Template:Back to Bogleheads Retirement Planning Start-Up Kit A charitable gift annuity is an instrument designed to allow an individual to make a gift to a favorite charity and still receive an income from the gifted capital. An individual irrevocably transfers cash or property to a charitable organization in exchange for the charity's promise to make fixed annuity payments to one or a maximum two life annuitants. Unlike other split-interest gifting vehicles, which are funded from an individual trust or pooled segregated fund, a gift annuity is considered a general obligation of the issuing charity. Many states require issuing organizations to be licensed and to maintain investment reserves. There are currently more than 4000 charitable organizations offering charitable gift annuities. Most charities use payout rates established by the American Council of Gift Annuities.

The average age of the income beneficiary receiving payments is 78 years of age. A donor can contribute cash or appreciated assets for an immediate gift annuity payment, or make contributions for a deferred payment at a future date. The annuitant is often the donor, but this does not necessarily have to be the case. A donor may establish an immediate gift annuity for an aged parent, or a grandparent may establish a deferred gift annuity for a young child. Payout rates are lower for younger beneficiaries; higher for older beneficiaries.[1] A 2004 ACGA survey found that the average size of a gift annuity contribution was $59,926. The median contribution was $28,027. [2]

How Income Payouts Are Determined

The income streams from a charitable gift annuity are determined by the size of the donation, the number of income beneficiaries and their ages, the choice of payout option, and the payout rate, as established by the ACGA Suggested Charitable Gift Annuity Rate.

Gift annuities offer the following payout options
  • Single Life
  • Joint Life
  • Successive
The latest ACGA Suggested Charitable Gift Annuity Rate is computed by the following input factors
  • The residuum realized by the charity upon termination of an annuity is 50 percent.
  • Life expectancies are based on the Annuity 2000 Mortality Tables for female lives with a two-year setback in ages. The rates also incorporate projections for increasing life expectancies.
  • Annual expenses for investment and administration are one percent of the fair market value of gift annuity reserves.
  • The total annual return on gift annuity reserves,periodically adjusted by the ACGA, and available at their website. This projection is based on an asset allocation plan consisting of 40% equities, 55% fixed income, and 5% cash.
  • The rates for the youngest and oldest ages are somewhat lower than the rates that would follow from the first four assumptions.[3]

A 2004 ACGA survey found that the median actual residuum realized by charities from contributions was 65.6 percent. [4]

Types of Gift Annuities

Gift Annuities are offered in both Immediate and Deferred Payout contracts.

Immediate Gift Annuity

With an Immediate Gift Annuity one donates cash or appreciated assets to a charity in return for an immediate lifetime income stream of payments. These payments can be on a monthly, quarterly, semi-annual, or annual basis. The most common payment period is quarterly payments. The payment occurs on the last day of the period. The initial payment is usually prorated.

Deferred Gift Annuity

A Deferred Gift Annuity allows a donor to contribute to a chosen charity and select a future payment date (at least one year from the contribution date). As with an Immediate Gift Annuity, income payments can be received on a monthly, quarterly, semi-annual, or annual basis. Quarterly payments are the most common payment period.

Tuition (College) Annuity

This Gift Annuity is a Deferred Gift Annuity established by a parent or grandparent for a young child, with the payment date deferred to the child's eighteenth birthday. The child can then elect lifetime payments, or more commonly, take a commuted value over four or five years. This type of Gift Annuity is not allowed by the state of New York.

Flexible (Deferred Payment) Gift Annuity

With a Flexible Gift Annuity, an annuitant does not have to select a set future start date for receiving payments, but rather selects an initial target date for initiating payments, usually at retirement. The charity will supply a range of payment rates surrounding the target date. Payout rates are linked to age, so later life payout rates are higher than earlier ones. [5]

Tax Attributes

Individuals who donate to a gift annuity can claim a charitable deduction for the gift, reduced by the present value of the expected income payments (as determined by IRS life expectancy tables and an IRS supplied discount rate). The IRS also imposes limitations on charitable deductions. If the donation is made with cash, the percentage limitation is 50% of adjusted gross income (AGI). If long-term appreciated property is transferred, the percentage limitation is 30% of AGI. Any deduction in excess of the applicable percentage limitation may be carried forward and taken during the five following tax years. A Donor also has the option of taking a "special election" and use the appreciated asset's basis, and not its fair market value, for valuing the donation. [6]

Taxation of income payments will depend on how the donation is funded.

Cash Donations

If the gift annuity is funded with cash, part of the payments will be taxed as ordinary income and part will be tax-free.

Appreciated Asset Donations

If funded with appreciated securities or real estate owned more than one year, and the donor is receiving the annuity payments, part of the payments will be taxed as ordinary income, part as capital gain, and part may be tax-free. If you as donor establish a gift annuity for someone other than yourself or your spouse, realize that unless you insert a clause in the contract reserving the right to abrogate the annuitant's right to income, you will be subject to the gift tax. This clause allows you to apply the annual gift tax exclusion to the yearly value of income distributions to the beneficiary annuitant. If your donation is appreciated property you will also be obligated to pay the capital gains tax on a donation, adjusted for the present value of the income interest. The charitable deduction should be sufficient to cover most of the capital gains tax.

Retirement Plan Donations

If the gift annuity is the beneficiary of a Retirement Plan (IRA) the income payments are taxable to the annuity beneficiary. The estate receives a charitable deduction for the contribution, adjusted for the present value of the payments that the beneficiary will receive (according to IRS life expectancy tables.)[7]

Sample Quotes

Many charities will provide on-line calculators that will provide the income and tax output for a given immediate or deferred donation.

Single Life Immediate Gift Annuity

The following sample quote, for a single life immediate gift annuity consisting of a gift of appreciated stock market assets, illustrates the tax attributes of the gift. Actual results will, of course, vary as payment rates and IRS discount rates change. Changes can also occur if mortality life expectancies change.

University of Virginia Thursday, September 04, 2008
Deduction Calculations
Summary of Benefits

Gift Annuity
ASSUMPTIONS

  • Beneficiary Age(s): 65
  • Gift Amount: $50,000.00
  • Cost Basis: $25,000.00
  • Gift Date: 9/4/2008
  • Payment Rate: 5.7 %
  • Payment Schedule: Quarterly

________________________________________

BENEFITS

  • Charitable Deduction: $17,273.00
  • Annual Payment: $2,850.00
  • Tax Free Portion: $822.22
  • Capital Gain Income: $822.23
  • Ordinary Income : $1,205.55

After 19.9 years, the entire annuity becomes ordinary income. Total reportable capital gain of $16,363.50 must be reported over 19.9 years. Partial payments for the year of gift will depend on the timing of your gift.
IRS Discount Rate is 4.2 %

Single Life Deferred Gift Annuity

The following sample quote, for a single life deferred gift annuity for a fifty year old donor, deferring the payout until age 66, and consisting of a gift of appreciated stock market assets, illustrates the tax attributes of the gift.

University of Virginia Monday, September 08, 2008
Deduction Calculations
Summary of Benefits

Deferred Gift Annuity
ASSUMPTIONS

  • Beneficiary Birth Date(s) 1/1/1958
  • Gift Amount $20,000.00
  • Cost Basis $10,000.00
  • Gift Date 9/8/2008
  • Date of First Payment 2/1/2024
  • Payment Rate 11.7 %
  • Payment Schedule Quarterly

________________________________________

BENEFITS

  • Charitable Deduction $8,031.40
  • Annual Payment $2,340.00
  • Tax Free Portion $313.56
  • Capital Gain Income $313.56
  • Ordinary Income $1,712.88

After 19.1 years, the entire annuity becomes ordinary income. Total reportable capital gain of $5,984.30 must be reported over 19.1 years If you reside in New York or New Jersey, the annuity amount may be less than the amount shown above. IRS Discount Rate is 4.2 %

How Charities Invest Charitable Gift Annuity Donations

The income payments a gift annuity annuitant receives are an obligation of the charity. The charity must therefore soundly invest the donated funds in order to meet its obligations to donor annuitants, as well as successfully maintain the 50% residual charity donation. Any failure to meet these funding requirements can force the charity to tap its general fund to make up shortfalls, or under the worst scenario, default on its promised payouts.

A charity assumes the following risks in offering gift annuities:

  • Rate Risk: The charity may offer overly generous payout rates;
  • Mortality Risk: The charity's gift annuity cohort of annuitants might live longer than expected life expectancy;
  • Investment Risk: The investment markets may not provide sufficient returns to fund the gift annuity's obligations. Diversification of asset allocations will reduce that risk, but appropriate asset allocation at any given time depends on a judgment about market conditions and risk tolerance.[8]
  • Asset Risk: A charitable gift annuity must sell the appreciated assets a donor gifts to the charity. The asset may fall in price before the charity can sell it.
  • Policy Risk: The charity's selection of minimum age and minimum donations for accepting gifts can affect the risk profile of the gift annuity investment pool.[8]

The risks can be offset to some degree by adopting prudent management and investment policies, and through prudent use of "reinsurance", the purchase of commercial immediate annuities to partially transfer mortality risk to an insurer. All purchased annuities belong to the charity.[9] [10]


How Gift Annuities Compare to Immediate Annuities

The 50% charitable residual in a gift annuity means that a charitable gift annuity's payout rate will be lower than the payout rate of a concurrent commercial insurance immediate annuity.[11]

The primary motivation for using a charitable gift annuity is therefore the charitable intent.

Considerations

Keep in mind the following considerations when weighing the use of a gift annuity:

  • A donation to a Charitable Gift Annuity is irrevocable, so you should definitely wish to be a benefactor to your chosen charity. Like all irrevocable decisions, you should be sure that you have no need for any lump sum you are considering donating. The charitable impulse should be the primary driver of your decision to donate.
  • The payout on a Gift Annuity is fixed and is thus exposed to inflation risk. This factor (combined with the higher payouts available at advanced ages) might explain why the average age of a Gift Annuity income recipient is 78 years old. Inflation risk is not as critical a factor for an older annuitant as it is for a younger annuitant.
  • A Gift Annuity is an obligation of the charity and is exposed to default risk. It is probably prudent to consider a gift annuity a supplement to one’s retirement income as opposed to being a major income source.
  • Keep in mind the tax consequences of the gift--including the limitations (50% of AGI on cash gifts and 30% of AGI on appreciated asset gifts) and five year carryforward-- on taking a charitable deduction. Be especially aware to the tax consequences of establishing a gift annuity for someone other than yourself or your spouse.
  • Deferred Gift Annuities represent a small portion of the market (about 5%) mostly attributable to the inflexibility of the selected payout date. If you are making deferred contributions consider using a Flexible Deferred Gift Annuity to eliminate this rigidity.
  • If your gift is large, or if you desire an income that is not fixed but can grow with the returns of an investment portfolio, you should consider other split-interest charitable vehicles,such as establishing a Charitable Remainder Trust, or making donations to a Charitable Pooled Income Fund.

References

  1. Gift Annuity Best Practices
  2. The Role of Gift Annuities In a Planned Giving Program, Frank Minton, TIAA-CREF Institute, p.10
  3. Underlying the Suggested ACGA Gift Annuity Rates
  4. The Role of Gift Annuities In a Planned Giving Program, Frank Minton, TIAA-CREF Institute, p.8
  5. ACGA Suggested Charitable Gift Annuity Rates
  6. Draw, Hold, or Call?, Give and Take, Sept, 2008.
  7. Charitable Gift Annuity Frank Minton, Planned Giving Design Center, LLC › PGDC Library
  8. 8.0 8.1 Maximizing the Benefits from Your Gift Annuity Program, Frank Minton, Planned Giving Design Center, LLC › PGDC Library
  9. Reinsurance of Gift Annuities - A Primer Robert F. Sharpe, Jr.
  10. Charitable Gift Annuity Reinsurance: The Top Ten Frequently Asked Questions Bryan K. Clontz, Planned Giving Design Center, LLC › PGDC Library
  11. Understanding the "Gift" in "Annuities Robert F. Sharpe, Jr., Give and Take, June, 2006.

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