Charitable Gift Annuities Help Establish Retirement Income, Tax Deductions
By Elaine Floyd, CFP
A very popular planned gift, charitable gift annuities can help older individuals establish retirement income, harvest income tax deductions, and support a favorite cause.
Charitable remainder trusts (CRTs) have long been popular vehicles for wealthy, philanthropically inclined individuals who want to receive income from trust assets while they are alive and have the remaining amount go to charity when they die. However, charitable gift annuities can accomplish the same objectives with less expense, more guarantees, and a lower administrative burden.
While there will always be a place for CRTs because they offer more control and flexibility, charitable gift annuities may be just the right income vehicle for people who wish to remove assets from their estate, expect to live a long time, and want whatever amount is left to go to a favorite charity.
Charitable gift annuities (CGAs) are issued by nonprofit organizations and are similar to commercial annuities in that they promise a fixed amount of income for life. The contract can be based on one or two lives, and the income can start immediately or be deferred to some future date.
The contract is secured by the assets of the charity—not the gift itself, as is the case with a CRT. This makes the income more secure and assures the client that no matter how long he lives or how the stock or bond markets perform in the years ahead, the income will continue for the rest of his life and the life of his joint annuitant, if applicable.
Charities that issue gift annuities are required by their state insurance departments to keep a certain level of assets in reserve to pay their annuity obligations. So, unlike a CRT, where the client manages trust assets and bears the risk of being able to make the lifetime income payments, a charitable gift annuity transfers the risk to the charity, which minimizes the risk by keeping the required level of reserves. In that respect, it is very similar to a commercial annuity.
Where the charitable gift annuity differs substantially from a commercial annuity is in the formula used to determine the income payments. Because this is, after all, a charitable giving vehicle that also happens to benefit the donor during his remaining life, the formula factors in a "residuum" that is generally 50% of the value of the gift.
The residuum is the amount that is expected to go to the charity if the donor lives his exact life expectancy. Because of this residuum, the annuity payments are lower than if a commercial annuity were purchased in the same amount. In exchange for the somewhat lower payments, the client has the assurance that if he dies early into the contract, the charity, and not some insurance company, will end up with his hard-earned money.
Annuity payout rates
As with any income annuity, the payout is based on the annuitant's age (i.e., life expectancy). The older the annuitant, the higher the payout. An easy way to calculate the income payments on a charitable gift annuity is to multiply the contribution by the "annuity rate" for the donor's age. These rates are suggested by the American Council on Gift Annuities, an organization established in 1927 to eliminate competition among charities in the setting of gift annuity rates and encourage donors to select charities based on their cause, not their rates.
You can find the complete table on the ACGA's website. Representative rates are as follows and can be paid monthly, quarterly, semiannually, or annually, depending on the terms of the agreement. To calculate the annual payment, simply multiply the contributed amount by the rate.
Table 1: Single Life |
Age |
Rate (%) |
Annual payment assuming
a $100,000 contribution |
40 |
4.7 |
$4,700 |
50 |
5.3 |
$5,300 |
60 |
5.7 |
$5,700 |
70 |
6.5 |
$6,500 |
80 |
8.0 |
$8,000 |
90 and over |
11.3 |
$11,300 |
Source: American Council on Gift Annuities
Table 2: Two Lives—Joint and Survivor
(See ACGA website for more combinations) |
Age of both
annuitants |
Rate (%) |
Annual payment assuming
a $100,000 contribution |
40 |
4.3 |
$4,300 |
50 |
4.7 |
$4,700 |
60 |
5.4 |
$5,400 |
70 |
5.9 |
$5,900 |
80 |
6.9 |
$6,900 |
90 |
9.3 |
$9,300 |
Source: American Council on Gift Annuities
The ACGA uses certain assumptions in the calculation of these annuity payout rates. These include a 50% residuum, 6% expected returns (5% for deferred-payment gift annuities), and a 1% annual expense load. Each charity may set its own payout rate, but most follow the guidelines of the ACGA.
To get an idea of how charitable gift annuity payments differ from commercial annuity payments, we see from the above table that a 70-year-old woman could receive an annual income of $6,500 on a $100,000 contribution to charity. According to the calculator at ImmediateAnnuities.com, the same amount placed in a commercial annuity would pay over $8,000 a year. Although these payment amounts do not take into account the tax benefits associated with charitable gift annuities, these products are not designed to compete with commercial annuities, so clients should have charitable intentions in addition to the desire to receive lifetime income.
Income taxation
When a donor contributes cash or property to charity in exchange for a gift annuity, it is technically part gift and part sale. The gift portion equals the value of the contributed property less the present value of the annuity. The donor may take a charitable tax deduction for the gift portion, subject to the applicable percentage limitation—50% of adjusted gross income (AGI) if the contribution is made in cash, or 30% of AGI if it's made with long-term appreciated securities. (The donor may make the special election to reduce the amount of his contribution by the appreciation in the property in order to be eligible for the 50% limitation.) Any excess deduction over the applicable percentage limitation may be taken in the five following tax years.
In the case of a deferred gift annuity, where payments do not begin within one year, the donor's deduction, as well as the payout rate, will be higher. A gift annuity payable to two annuitants for their joint lives would result in a reduced income tax charitable deduction since the payout period would be expected to be longer and therefore increase the "sale" portion at the expense of the "gift" portion.
Depending on the type of property contributed, the annuity payments may consist of three types of income:
- Tax-free return of principal. This is included in each payment until the assumed cost of the annuity—the "sale" portion (as determined under IRS tables)—has been fully recovered when the annuitant reaches life expectancy.
- Long-term capital gains. These are recognized on the "sale" portion and may be spread out over life expectancy as long as the donor names himself and no more than one other person as annuitant.
- Ordinary income. This is the portion of each payment that remains after the tax-free return of principal and capital gains portions have been determined. When the annuitant(s) attains life expectancy, all principal attributable to the sale portion will have been recovered income tax free and all capital gain attributable to the sale portion will have been recognized. Thereafter, all of the annuity income will be taxable as ordinary income.
This charitable gift calculator shows the amount of the charitable deduction and the portion of each payment attributable to tax-free return of principal and ordinary income assuming the contribution is made in cash. Gifts of property are more complex, and calculations will depend on the donor's basis. The client's tax advisor and the charity issuing the annuity can help with the calculation.
CGAs vs. CRTs
Charitable gift annuities are much easier to establish and maintain than charitable remainder trusts. There are no setup costs involved, and the client does not have to worry about ongoing management or administration (the payout formula takes into account an annual expense fee of 1% or so). The income is a fixed amount for life, and the assets of the charity, not merely the assets placed in trust, stand behind the promise of income.
Taxation of charitable gift annuity payments is generally more favorable than CRT income. With a gift annuity, a portion of each payment is tax-free return of principal; a CRT, on the other hand, must distribute ordinary income and short-term capital gain income before distributing trust corpus or long-term capital gains.
CRTs do offer more control and flexibility for clients with complex tax and estate-planning needs. However, the charitable gift annuity may be right for those clients who simply want to make a gift to charity in exchange for income they can't outlive.
Risks of CGAs
The two primary risks to the annuitant are default risk and inflation. The annuity payments are a general, unsecured liability of the charity, and if the charity becomes insolvent and exhausts its reserve funds, annuity payments would stop.
And, like any other annuity, the donor may lose purchasing power, as the payments remain fixed over a lifetime. According to the Planned Giving Design Center, the "security of fixed payments begins to outweigh the lack of inflation protection" at age 77. Younger donors may want to consider another vehicle if inflation is a concern.
Finally, clients should realize that a CGA is irrevocable and the assets will pass on to the charity at the annuitant's death. There have also been instances of fraud, so be sure to thoroughly check out the charity's credentials.
CGAs are one of most popular life-income gift arrangements for donors who like the idea of a secure income stream, tax deductions, and supporting the charity of their choice. Gift annuities can often be arranged for as little as $5,000 to $10,000 depending on the institution, and personalized for each client. Be sure to review any arrangement with clients' tax and legal advisors.
Resources
Sponsoring charities, American Council of Gift Annuities
Charitable gift annuities, Michigan State University
"Maximizing the Benefits From Your Gift Annuity Program," Planned Giving Design Center
"Twelve Uncommon Things You Can Do With a Gift Annuity," Planned Giving Design Center
"Charitable Gift Annuity," Planned Giving Design Center
Elaine Floyd, CFP, is a former stockbroker with an NYSE-member firm. She writes books, articles, and online courses on investing and personal finance and is the author of J.K. Lasser's Investor's Tax Guide. She is based in Bellingham, Washington.
Back to
ARTICLES.
