A 10 Minute Course in Charitable Gift Annuities

Q. What is a Charitable Gift Annuity (CGA)?
A. A CGA is a Written Agreement Between a Donor and a Charity:

  • In exchange for a Donation, the Charity agrees to make payments for life, to either one or two annuitants, usually husband and wife.
  • The donation is partly an outright gift to the charity, and partly the purchase of the stream of lifetime payments.
  • The donor will receive a tax deduction for the portion of the donation that is the outright gift to the charity.

First, the donor transfers cash or other assets to the Charity:

  • Then the Charity sells the asset without paying immediate capital gains tax, and re-invests in a diversified portfolio.
  • The Annuitants begin receiving payments on a monthly, quarterly or annual basis.
  • At the death of the last annuitant, the payments cease.
  • At the option of the Charity, the donor may have been given the choice to direct the charitable use of the remaining gift annuity reserve account.

The income tax deduction can be influenced by several factors:

  • The present value of the stream of payments
  • Life expectancy
  • The fair market value of the assets
  • Payout rate
  • Type of Gift Annuity
  • Payment mode
  • Federal mid-term Rate (IRC Sec. 7520)
  • Deduction limits, generally 30% or 50% of adjusted gross income, depending upon whether the donation involves appreciated assets.

The lifetime payment options include:

  • Payments to begin immediately
  • Payments to be deferred to a point in time in the future
  • Payments to be used for College Education over 2 to 10 years
  • Payments to be deferred and commenced at some future point within a range of years
  • Payments may be for one life only
  • Payments may be for joint lives, continuing to the survivor
  • Payments may be to one person only, then to another after the death of the first

Depending on which payment option you choose, there are issues you must consider:

  • If payments are deferred, the payout rate will be higher
  • Payments will be made annually or monthly, but are usually quarterly
  • Deferral options should be discussed with your advisor at the charity
  • The longer the deferral, the greater the immediate tax deduction
  • Term of years Gift Annuities are permitted if deferred for one year

The donor is entitled to these benefits:

  • Current income tax deduction
  • Capital gains tax avoidance on the immediate gift portion
  • Capital gains tax deferral on the annuity portion
  • Increase in the annuitant’s lifetime income stream
  • Potential to direct social capital
  • Possibility of up to half of the payments to be tax-free

The following are basic types of CGA’s:

  • Immediate Gift Annuity
  • Deferred Gift Annuity
  • College Gift Annuity
  • Retirement Gift Annuity

The following are the characteristics of an immediate Gift Annuity:

  • Payout is based upon the initial donation and age of donor/annuitant(s)
  • Payments remain constant throughout the life or lives of the annuitant(s)
  • No future contributions are allowed
  • Typically used for older donors (65+) who desire a completely predictable income
  • All growth of the fund accrues to the charity and not to the annuitants

The following are characteristics of a deferred Gift Annuity:

  • Payout is based upon the future value of the reserve account, determined in advance
  • The payment stream can be set to begin at a specified future date, or within a range of dates
  • The amount of the future payment stream is known in advance and is guaranteed
  • Future contributions are allowed
  • Benefit of the deferral accrues to both the annuitant and to the charity

The following are characteristics of a College Gift Annuity:

  • Payments can be set to begin at any future predetermined date
  • The payments can be set to coincide with future tuition expenses
  • The payments essentially compress a lifetime of payments into a short period of time
  • The payments can be for as short a time as two years, and a maximum of ten years
  • Future contributions are allowed
  • There is the potential to control how the funds are used for education

Income tax considerations:

  • The charity is a tax-exempt entity
  • The payments to the annuitant(s) are guaranteed
  • The charity takes on the cost basis of assets transferred to it. Part of any capital gains is forgiven forever
  • Part of the payments will be ordinary income, and part may be tax free, unless appreciated assets are donated, in which case, part of what would have been tax free will be taxed at long-term rates

Next, we will illustrate the accounting which might appear for a gift of appreciated stock:

  • Mr. and Mrs. Smith transfer $1,000,000 of stock with a $500,000 cost basis for a Gift Annuity
  • The Gift Annuity calls for payments of $75,000 per year
  • The charity sells the stock and invests the funds in its annuity reserve portfolio
  • $37,000 of the payments are taxed at ordinary income tax rates
  • $17,000 of the payments are taxed at long term capital gain rate of 20%
  • $11,000 of the payments are tax free, until the end of their joint life expectancy
  • At the end of their joint life expectancy, all future payments will be taxed at ordinary income rates

General questions:

  • Who can be the annuitants?
  • Do I lose complete control of the assets?
  • Which type of CGA makes the most sense for my situation?
  • How much does it cost to set up a CGA? And what are the annual maintenance requirements and costs?

Gift tax ramifications:

  • Non-spousal annuitants
  • Retention of right to revoke payments to an annuitant by will
  • The immediate gift portion qualifies for a charitable gift tax deduction
  • Payment interest is a property right
  • Annual gift tax exclusion applies for a gift of present interest

Estate tax ramifications:

  • Annuity assets are not included in the estate of the donor
  • The donation is immediately removed from estate and claims of current or future creditors
  • Payments left to a spouse qualifies for the unlimited marital deduction
  • A non-spousal annuitant will disqualify you from taking the marital deduction

With the charity’s prior permission, you may request that the remaining reserves be given to:

  • Any public charity
  • Charitable, religious, educational, scientific or health related charities
  • A family foundation
  • You may choose as many as the charity will permit
  • With the charity’s prior permission you may change your mind

Suitable assets to contribute:

  • Marketable securities
  • Readily marketable real estate
  • Closely held readily salable stock
  • Readily salable partnership interests
  • Cash
  • Readily marketable notes
  • Fixed and variable annuities (usually best to surrender the annuity first and donate cash)

The charity invests the funds in the Gift Annuity Reserve Portfolio in:

  • Stocks
  • Bonds
  • Money market instruments
  • Guaranteed Mortgage Backed Securities
  • Other types of managed accounts

Factors to consider in choosing a Charitable Gift Annuity:

  • The CGA is a very simple arrangement
  • The payment rates are usually based upon the American Council on Gift Annuity rates (ACGA)
  • There is no trust document required
  • Risk tolerance can be very low, since issuing charity guarantees payments
  • Can be used for either current needs or future needs
  • Most charities allow requests to benefit other charities with a portion of the funds
  • There is no set-up fee
  • There are no ongoing administration fees
  • There is no need for an attorney to draft documents (we always recommend you consult your advisors)

What control does donor retain?

  • Donor must give up control of donated assets
  • Donor cannot have his investment advisor control assets
  • Donor may retain right by will to cancel remainder annuitant’s payment stream
  • Donor has no need to receive statements for the reserve account since payments are guaranteed

Advantages and disadvantages of the Charitable Gift Annuity:

Advantages:

  • Simplicity, just like receiving fixed pension payments
  • Flexibility and ease of implementation
  • Design choices are easy – immediate payments or deferred

Disadvantages:

  • No possibility to amend agreement to meet changing conditions
  • No ability to make changes
  • Charity does not report on reserve fund performance
  • No ability to change charities

Irrevocable but flexible as to design:

  • Much smaller amounts are acceptable, compared to Charitable Trusts
  • Usually no legal or accounting fees, except for possible review by advisors
  • Charity will cooperate in the use of the remaining reserve account

Who can benefit from a Charitable Gift Annuity:

  • People who need to sell an asset:
  • Because the time is right
  • To increase their current income
  • To increase their retirement income
  • To delegate asset management and achieve diversification
  • For income tax planning
  • For estate tax planning
  • For gift tax planning
  • People who desire to give
  • Can increase the size of the gift due to income or estate advantages
  • Can make a gift that they would otherwise feel uncomfortable giving

Primary criteria:

  • Highly appreciated assets
  • Low yielding assets
  • Needing or wanting to sell

The following is a case study to help you better understand a CGA:

  • The Wilson’s set up a CGA and choose to name themselves as annuitants
  • They transfer the asset over to the charity. They immediately receive a tax deduction of $256,740, a savings of $92,426.
  • The charity will immediately sell the asset and reinvest the money in a diversified portfolio.
  • And they pay absolutely no immediate capital gains tax on the sale of the stock.
  • A portion of the capital gains tax is forgiven forever, and a part will be recovered during their life expectancy, within the payments, and taxed at the lower long term capital gains rate.
  • They then begin to receive an annual income of $80,000 in accordance with the ACGA payment rates used by the charity.
  • From their large tax refund they received and out of their newly enhanced income stream, they decide to transfer a small amount each year to a special wealth replacement trust for the benefit of their kids and grandchildren.
  • The net result…John and Mary Wilson received a sizable up-front tax deduction, significant capital gains tax savings and enhanced lifetime payments. After their deaths, the Charity will transfer the remaining reserves to their family foundation or other chosen charity. In this case, they had established The John & Mary Wilson Family Foundation to benefit various charities that they were interested in. The Wilson's have created a social legacy. And the Wilson children receive $1,000,000 cash, tax-free, as the beneficiaries of the Wealth replacement trust the Wilson's established.

Conclusion:

  • Taxes force people to part with a portion of their wealth
  • Most people are totally unaware that they have a choice about how their social capital is directed
  • The use of a charitable gift annuity can be a key tool in recognizing, capturing, and redirecting one's social capital

Providing for children:

  • One donor, Mrs. Eleanor B., funded gift annuity for her two grandchildren for their college education, which will be 13 and 15 years from now.
  • She has scheduled payments to be paid over a 5 year duration for each of them anticipating that the grandchildren will attend four years of under- graduate school, perhaps one year of graduate school).
  • She said " this is the first gift I've made that gives me a tax deduction, moves money out of my estate, and assures that the grandchildren will have an adequate college education."


Gift annuities for retirement:

  • Mr. and Mrs. Peter D., longtime donor-advisors of their foundation, contributed to two charitable gift annuities over the past two years.
  • They used highly appreciated stock, which they felt comprised too much of their portfolio, and may not always hold its current value.
  • These gift annuities are intended for their retirement in about twelve years, and so payments will be deferred for that period of time, when they will provide much higher payments than if they started the payments immediately.
  • "I thought I could accomplish a number of purposes at the same time," says Mr. D. concerning the gift annuities. "I could help fund our foundation for our children to carry on, which is very important to me and my wife, and we could reduce our risk of exposure to the one major stock holding in our portfolio.
  • And we can diversify investments to assure that it has the potential to grow in value."

Last minute Estate Planning:

  • Gift annuities are one of the easiest tools to use in last minute Estate Planning.
  • The simplicity of the tool makes it easy for all family members to understand, and it has become a preferred vehicle to provide an assured income stream to heirs, whether they are children or grandchildren.

Are Gift Annuities available in all States?
TCN does not offer Gift Annuities in California, Wisconsin, New York, New Jersey and Washington State. The reasons involve the constraints that are placed on the investments in the reserve account and other considerations. In lieu of Gift Annuities, the use of Charitable Remainder Trusts, especially the Charitable Remainder Annuity Trust are very effective replacement tools. Contact us for details on these alternative charitable planning instruments.