Charitable gift annuities - doing well by doing good?

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Small Savanna
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Charitable gift annuities - doing well by doing good?

Post by Small Savanna » Sat Nov 16, 2019 10:28 am

Now that the kids are out of college and our retirement plan is on track, we’ve been thinking about making some larger charitable donations. I’ve discovered something called a charitable gift annuity that almost seems too good to be true, assuming you fund it with appreciated stock. Here is an example of how it seems you can donate appreciated stock and apparently get a bigger payout while supporting a charity, compared to just selling the stock and buying an annuity:

Scenario A: Our top two appreciated stocks have a current value of $62K and a basis of $12K. If we sell them, the capital gains tax will be 15% federal + 3.8% net investment income tax + 6% state = 24.8% * ($62K - 12K) = $12,400. Let’s assume that at age 65 I sell the stock and use the after-tax proceeds to buy an immediate annuity with an annual payout of 6.31%. The payout is approximate, but sourced from immediateannuities.com. My annual income will be:

(62K – 12.4K)*0.0631 = $3130

Scenario B: Give the appreciated stock to a charity in return for a monthly payment. A large university is advertising a 5.4% annual payout for gift annuities at age 65, so this is presumably in the ballpark for what other charities pay. My annual income will be:

62K*0.054 = $3348

In addition, if we itemize, there is a tax savings in the current year equal to the value of the charitable donation minus the present value of the annuity. I’m having a harder time calculating that, but believe it would be several thousand dollars. Our combined federal and state marginal rate is 24%+6% = 30%

It seems like the charitable annuity strategy provides benefits in a few ways - getting a charitable deduction now while we are in a higher bracket and still doing itemized deductions, avoiding capital gains taxes on appreciated assets that we would like to get out of, and getting most of the annuity payments at a time when we may be in a lower tax bracket.

Question for Bogleheads: Does anyone have practical experience with charitable annuities, and are the numbers and tax calculations above consistent with your experience? Are the annuity payments fully taxable in the year you get them? Also, it is better to give money to charity from appreciated stocks in a taxable account, or from an IRA to avoid RMDs? Are there other charitable giving strategies that have similar tax benefits?

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Re: Charitable gift annuities - doing well by doing good?

Post by HEDGEFUNDIE » Sat Nov 16, 2019 10:56 am

Wiki article: https://www.bogleheads.org/wiki/Charitable_gift_annuity

Your annuity payments will be only partly taxable; the portion that is considered return of principal is not taxed.

The only downside appears to be default risk of the university.

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Re: Charitable gift annuities - doing well by doing good?

Post by nisiprius » Sat Nov 16, 2019 11:14 am

A detail not mentioned in the Wiki article and worth thinking about is that charitable gift annuities, in most states, are, legally, not insurance.They are regulated in their own specific way, but they are not regulated as insurance. You cannot find "financial strength" ratings from A. M. Best, Moody's, etc. The charity does not need to be a member of the state guaranty association and the annuity owner is not protected by the state guaranty association. The details are complicated and vary by state. One typical block of verbiage from that web page:
Michigan Code does not address exemption of charitable gift annuities from insurance regulation. However, Attorney General Opinion (Opinion No. 6538) held that a gift annuity program proposed by the Michigan State University Foundation was not subject to regulation under the Insurance Code. In addition, the Attorney General stated that regulation would not be imposed unless issuance of annuities became the chief purpose of the foundation. The office of the Commissioner of Insurance views the opinion as applying to any legitimate charity.
I don't know how to find data on how often CGAs have gotten into trouble or what that meant for annuity holders. Because CGAs are intended to provide meaningful charitable donations, they pay out less than ordinary insurance-company insurance and that probably gives them a built-in safety margin of sorts.

Another concern is that there are fraudulent schemes, preying on seniors, that pretend to be charitable gift annuities. I assume this would not be a problem with a university or well-known legitimate charity. However, according to the SEC, phony CGAs are among the Most Common Elder Investor Scams:
Charitable Gift Annuities: In this type of scheme a fraudster will pose as a charitable organization offering monthly annuity payments in exchange for payments which purportedly will be invested to both pay an annuity to the investor and to benefit charitable organizations. Unbeknownst to the investor, a significant portion of the monies are not being invested for charitable purposes, but go directly to the fraudsters’ personal account. The charitable organization is merely a front. When investing in charitable annuities, investors should make sure that the salesperson is representing a legitimate charitable organization and that the organization is fully aware of the salesperson’s activities. For example, the SEC found one fraudster that raised at least $52.9 million through the sale of Charitable Gift Annuities. He represented to investors that their funds would go into stocks, bonds and money market accounts, but $19.2 million of the monies raised were diverted to a hidden account that afforded him a luxurious lifestyle. To keep the Ponzi scheme running, he used $7.9 million of investors' money to pay earlier investors and spent $3 million in commissions to sales agents. When the plan collapsed, he told investors that Mid-America had "disbanded due to inadequate assets." [See Securities and Exchange Commission v. Robert R. Dillie and Mid-America Foundation, Inc., Defendants, and Mid-America Financial Group, Inc., Relief Defendant (U.S.D.C., District of Arizona, Phoenix Division, Civil Action No. CV-01-2493-PHX-JAT)]
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Re: Charitable gift annuities - doing well by doing good?

Post by Gill » Sat Nov 16, 2019 11:45 am

Keep in mind, a CGA really only makes sense if there is a charity you wish to benefit. In other words, the arrangement may not be quite as attractive as other possibilities, but if you wish to benefit a charity while retaining some income from the gift it can be attractive.
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Re: Charitable gift annuities - doing well by doing good?

Post by HEDGEFUNDIE » Sat Nov 16, 2019 11:48 am

Gill wrote:
Sat Nov 16, 2019 11:45 am
Keep in mind, a CGA really only makes sense if there is a charity you wish to benefit. In other words, the arrangement may not be quite as attractive as other possibilities, but if you wish to benefit a charity while retaining some income from the gift it can be attractive.
Gill
But in the OP’s case it appears the CGA is the best available annuity option.

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Re: Charitable gift annuities - doing well by doing good?

Post by sport » Sat Nov 16, 2019 12:07 pm

Small Savanna wrote:
Sat Nov 16, 2019 10:28 am
Are there other charitable giving strategies that have similar tax benefits?
One of the best strategies is using Qualified Charitable Distributions (QCDs). These can be part of your RMD, yet are not taxable for federal taxes and possibly state income taxes as well. However, you must be older than 70.5 at the time of the donation.

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Re: Charitable gift annuities - doing well by doing good?

Post by WoodSpinner » Sat Nov 16, 2019 12:09 pm

OP,

Thanks for the post — interesting idea....

Can the asset be in an IRA? Does that change the analysis?

WoodSpinner

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Re: Charitable gift annuities - doing well by doing good?

Post by dodecahedron » Sat Nov 16, 2019 12:16 pm

HEDGEFUNDIE wrote:
Sat Nov 16, 2019 11:48 am
Gill wrote:
Sat Nov 16, 2019 11:45 am
Keep in mind, a CGA really only makes sense if there is a charity you wish to benefit. In other words, the arrangement may not be quite as attractive as other possibilities, but if you wish to benefit a charity while retaining some income from the gift it can be attractive.
Gill
But in the OP’s case it appears the CGA is the best available annuity option.
Not clear. The OP did not take into account the fact that the $3,130 cash flow stream from the conventional annuity will be taxed quite differently from the $3,348 cash flow stream. Very little of the $3,130 cash flow stream will be taxable until the OP reaches life expectancy (at which point the cost basis of the annuity will be exhausted and any payments beyond that would be taxable.) By contrast, more of the $3,348 cash flow stream will be taxable immediately, some at capital gains rates, some at ordinary income rates.

This is not a no-brainer decision purely on tax breaks alone, given that under current law tax rates are scheduled to go up in 2025. The second option gives a substantial upfront tax break now but increases taxable income in the future.

Given the tax complexity and resulting future uncertainty, I would say that this kind of gift is only worth considering if (1) you really want to donate to the underlying charity and (2) you have bulletproof confidence in the financial managers of the nonprofit to keep the organization solvent in the future.

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Re: Charitable gift annuities - doing well by doing good?

Post by HEDGEFUNDIE » Sat Nov 16, 2019 12:23 pm

dodecahedron wrote:
Sat Nov 16, 2019 12:16 pm
HEDGEFUNDIE wrote:
Sat Nov 16, 2019 11:48 am
Gill wrote:
Sat Nov 16, 2019 11:45 am
Keep in mind, a CGA really only makes sense if there is a charity you wish to benefit. In other words, the arrangement may not be quite as attractive as other possibilities, but if you wish to benefit a charity while retaining some income from the gift it can be attractive.
Gill
But in the OP’s case it appears the CGA is the best available annuity option.
Not clear. The OP did not take into account the fact that the $3,130 cash flow stream from the conventional annuity will be taxed quite differently from the $3,348 cash flow stream. Very little of the $3,130 cash flow stream will be taxable until the OP reaches life expectancy (at which point the cost basis of the annuity will be exhausted and any payments beyond that would be taxable.) By contrast, more of the $3,348 cash flow stream will be taxable immediately, some at capital gains rates, some at ordinary income rates.
The exclusion ratios for immediate annuities and CGAs are similar. You are also ignoring the upfront tax deduction that the OP gets from the CGA.

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Re: Charitable gift annuities - doing well by doing good?

Post by dodecahedron » Sat Nov 16, 2019 12:42 pm

HEDGEFUNDIE wrote:
Sat Nov 16, 2019 12:23 pm
The exclusion ratios for immediate annuities and CGAs are similar.
Somewhat similar, but not exactly the same. Very little of the immediate annuity will be taxable until the cost basis is exhausted. By contrast, a somewhat larger portion of the CGA will be taxable, some of it at capital gains rates and some at ordinary income rates. The CGA will definitely have a higher ongoing impact on AGI until the year the cost basis is exhausted.
You are also ignoring the upfront tax deduction that the OP gets from the CGA.
I am not ignoring it. I am just saying this is not a no-brainer on taxes alone, given that currently taxes are ¨on sale¨ at rates scheduled to revert to higher levels in the future.

An upfront deduction in exchange for a higher future stream of taxable income *and* AGI may or may not be a good deal. A variety of idiosyncratic personal factors (e.g., tax-hump/torpedo issues, the extent to which the OP can currently benefit from an additional itemized deduction this year vs in the future due to other expected taxable cash flow streams such as SS, pensions, or RMDs) complicate the issue.

I have personally given a lot of thought to this issue and concluded that for my particular expected tax parameters this would not be the ideal way to receive an annuity. It might well be a different calculation for someone else with a different set of expected future tax parameters. That is why I said it was not necessarily a no-brainer on purely tax terms alone.

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Re: Charitable gift annuities - doing well by doing good?

Post by dodecahedron » Sat Nov 16, 2019 1:00 pm

Small Savanna wrote:
Sat Nov 16, 2019 10:28 am
Are the annuity payments fully taxable in the year you get them?
No. Some of the CGA annuity payment will be excluded from AGI and taxable income as a return of basis. Similarly some of the SPIA will be excluded from AGI and taxable income as a return of basis. However, any upfront deduction you get this year for the CGA will reduce your basis in the CGA relative to the basis in the SPIA. It is a complicated comparison to make with many moving parts.

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Re: Charitable gift annuities - doing well by doing good?

Post by Eric » Sat Nov 16, 2019 4:21 pm

Under the tax rules, the charity's interest must be more than 10%. In other words, on an actuarial, net present value basis, the donor must be expected to get back less than 90% of what they put in. Possibly the donor could still come out ahead after tax in limited circumstances, but I'd check the figures carefully.

As a practical matter, most charities aim for a 50% charitable residue, not just the minimum required under the tax rules. (The American Council on Gift Annuities established this guideline.) At that level, it's hard to see how the donor would ever come out ahead. Of course, that's fine with many donors -- they understand they'll come out behind, and intend to make a substantial charitable gift.
Last edited by Eric on Sat Nov 16, 2019 4:38 pm, edited 1 time in total.

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Re: Charitable gift annuities - doing well by doing good?

Post by bluquark » Sat Nov 16, 2019 4:37 pm

This sort of complex product is designed more for people whose entire large net worth is tied up in a business and they wish to exit. E.g. if your company IPOs for $20M and you want to diversify into index funds without creating a massive taxable event and also preallocating some of it to charity.

For amounts on the order of $60K I would suggest simply straight-up donating one part of it via a DAF and simply selling the other part, in the same proportions as the net present value of the income stream you want. The majority of the tax benefits from any charitable instrument come from the avoidance of sale on the donated part. The more complex schemes only get modest additional benefits on the time-value of the tax on the income part. The latter is unlikely to be worth more than a few percent.

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Re: Charitable gift annuities - doing well by doing good?

Post by grabiner » Sat Nov 16, 2019 4:41 pm

Eric wrote:
Sat Nov 16, 2019 4:21 pm
Under the tax rules, the charity's interest must be more than 10%. In other words, on an actuarial, net present value basis, the donor must be expected to get back less than 90% of what they put in. Possibly the donor could still come out ahead after tax in limited circumstances, but I'd check the figures carefully.

As a practical matter, most charities aim for a 50% charitable interest, not just >10%. (A group of major charities established this guideline.) At that level, it's hard to see how the donor would ever come out ahead. Of course, that's fine with many donors -- they understand they'll come out behind, and intend to make a substantial charitable gift.
The standard formula is 50% of the value at your life expectancy, which is less than 50% of the present value. The 10% rule means that very young annuitants may get a lower payout than the 50% formula would give.

But the OP has the correct comparison. The reason you should make a charitable gift annuity is that you want to make a donation to charity and get an income stream. Doing those two things in a single transaction may be a better deal than donating stock directly to the charity and buying a retail annuity.
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Re: Charitable gift annuities - doing well by doing good?

Post by nisiprius » Sat Nov 16, 2019 4:45 pm

Small Savanna wrote:
Sat Nov 16, 2019 10:28 am
A large university is advertising a 5.4% annual payout for gift annuities at age 65, so this is presumably in the ballpark for what other charities pay.
Since you use words like "we" and "our," I am thinking that you want a two-life joint-and-survivor annuity which keeps paying as long as either member of the couple survives. Such annuities will pay less than a single-life annuity (because the chances are they will need to keep paying it longer).

Virtually all charitable gift annuities are members of the American Council on Gift Annuities, and follow a rate schedule developed by that council. The schedule is here. They are showing a payout of 5.1% at age 65 for a single life, 4.5% for a couple both aged 65.

It's interesting that your university is showing 5.4%. You might want to double-check that. I'd been about to say there's no point in comparison shopping because they all follow the same rate schedule. I'm not sure what's happening here. You should contact the university and resolve whether a) they belong to the ACGA or not, and whether b) their rate schedule is up-to-date or not.

(The organizations didn't want to be in a competitive situation, and got Congress to pass a special law exempting them from antitrust legislation, so they could all offer the same rates without being accused of price-fixing).
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Re: Charitable gift annuities - doing well by doing good?

Post by Eric » Sat Nov 16, 2019 5:12 pm

grabiner wrote:The standard formula is 50% of the value at your life expectancy, which is less than 50% of the present value. The 10% rule means that very young annuitants may get a lower payout than the 50% formula would give.
You’re right. I started to correct that with an edit, but not as clearly as you just did, and not fast enough to beat your comment. ;-)

I’m still skeptical that the figures will work out favorably in many cases, for someone who doesn’t have at least some charitable motivation. “Very young annuitants” would be a pretty unusual scenario for a CGA.

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Re: Charitable gift annuities - doing well by doing good?

Post by Small Savanna » Sun Nov 17, 2019 5:26 pm

To all who replied - thank you! I'm consistently impressed with the level of expertise that Bogleheads can bring to almost any topic!

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Re: Charitable gift annuities - doing well by doing good?

Post by BuddyJet » Sun Nov 17, 2019 5:46 pm

While not really in response to your question, you might also consider a charitable remainder trust if the amount is large enough to justify the drafting. It allows a bit more flexibility in the payout percentage and current donation amount. At donor's passing, trust isn't limited to donation to one charity.

I set one up 20+ years ago and it pays to my donor advised fund at my death so my spouse and then children can continue the grant process.
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Re: Charitable gift annuities - doing well by doing good?

Post by inbox788 » Sun Nov 17, 2019 7:05 pm

If you don't need the immediate income or aren't it to diversify, similar to delaying the purchase of an SPIA, you could wait and let your equities grow and/or might draw a higher percentage rate. Time it to coincidence with a higher marginal tax rate and one when you itemize and make other charitable contributions. You may soon run out of higher tax years, but adding additional income now is only being taxed at the higher rate.

Another thought is do you really need guaranteed additional income? SWR nearly matches and you leave behind a legacy, or can draw down at similar rates. And if you donate QCDs instead, you reduce your future taxable income. If you want the annuity and donation, it's one way of doing it, but I question the need for annuity for most folks. I've looked into CRAT/CRUT, but for now leaning towards 4% SWR and donating QCD for now.

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Re: Charitable gift annuities - doing well by doing good?

Post by nisiprius » Sun Nov 17, 2019 9:17 pm

Small Savanna wrote:
Sun Nov 17, 2019 5:26 pm
To all who replied - thank you! I'm consistently impressed with the level of expertise that Bogleheads can bring to almost any topic!
However, I really am quite curious as to whether your university is currently advertising a higher payout--5.4% at age 65--than this schedule, published by the American Council on Gift Annuities. Could you check that out, please?
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Re: Charitable gift annuities - doing well by doing good?

Post by Small Savanna » Wed Nov 20, 2019 6:01 am

nisiprius wrote:
Sun Nov 17, 2019 9:17 pm
Small Savanna wrote:
Sun Nov 17, 2019 5:26 pm
To all who replied - thank you! I'm consistently impressed with the level of expertise that Bogleheads can bring to almost any topic!
However, I really am quite curious as to whether your university is currently advertising a higher payout--5.4% at age 65--than this schedule, published by the American Council on Gift Annuities. Could you check that out, please?
I just checked, and they still are showing 5.4% for a single immediate annuity at age 65. This is in a table of examples that also includes other ages, two beneficiaries, etc. It's certainly possible that one or the other of the websites is out of date.

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