Posted June 1st, 2016

Charitable Gift Annuities – A Primer

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Questions and Answers about a popular gift vehicle.

In recent years, a growing number of charities have begun to offer charitable gift annuities as a component of their major and planned gift development programs. According to the most recent survey conducted by the American Council on Gift Annuities (ACGA), 20 percent of organizations issuing gift annuities had been doing so for less than 10 years.

Another 28 percent had been offering gift annuities for 10 to 19 years, and just under half, 48 percent, had been doing so for less than 20 years. Most planned giving experts would agree that charitable gift annuities have become one of the most popular charitable gift planning techniques. In fact, they are second only to charitable bequests in the number of individual planned gifts each year.

Question: How does a gift annuity work?

Answer: A donor transfers cash or other appropriate property, such as marketable securities, to a charity in exchange for fixed payments for one or two lives.

Question: How is the payment rate determined?

Answer: The payment rate is based on a number of factors, primarily the donor’s age at the time payments are to begin. It is set with the goal of the charity being left with 50 percent of the gift amount at the death of the person or persons receiving payments.

Question: Is there an income tax deduction when the gift annuity is funded?

Answer: Yes. Because the donor receives payments for life, the amount used to fund a gift annuity is not fully deductible. The donor is typically entitled to a charitable income tax deduction equal to 35 percent to 50 percent of the amount transferred.

Question: How are the payments of a gift annuity treated for tax purposes?

Answer: The answer depends on whether the contract is funded with cash or with appreciated property. In the case of cash, the payment is divided between ordinary income and a tax-free return of the original investment in the contract that continues for the life expectancy of the person(s) receiving payment. When the donor uses appreciated assets such as stock to fund a gift annuity, there is no tax on the capital gain allocated to the gift component of the transaction, and the remainder of the gain is reported by the donor as capital gain until the entire non-charitable portion of the gain has been accounted for. Other rules apply when funding a gift annuity for someone other than the donor with appreciated assets.

Question: Can you give an example? 

Answer: Suppose Jane, age 73, uses $25,000 in cash to fund a gift annuity. Her annual payment of $1,375 (5.5 percent of the amount transferred) would be divided between a taxable and non-taxable portion for her life expectancy of 13.8 years, after which the payments would be fully taxable. If the gift annuity were funded with stock purchased for $5,000 but that is currently worth $25,000, her payments would be treated as follows:

Tax Free $213.12
Capital Gain $852.51
Ordinary Income $309.37

If the annuity were funded with cash, the entire amount of the payment not treated as return of investment would be received free of tax. Regardless of the property used to fund her gift annuity, after 13.8 years, the payments would be viewed as all ordinary income. In either case, she would also receive a current income tax deduction of $10,303. This favorable capital gains treatment is only applicable to individuals or married couples. If someone else is to receive payments, a portion of the capital gains tax must be paid in the year the annuity is established. Because Jane is the only recipient of the annuity payments, the amount used to fund her gift annuity would not be part of her estate.

Question: Is the amount used to fund a gift annuity removed from the donor’s taxable estate?

Answer: In most cases the amount of the gift annuity will not be included so long as the payment recipient is the donor and/or the donor’s spouse. A portion of the gift annuity will be included in the donor’s estate if a person other than a spouse receives payments from the annuity following the donor’s death.

Question: Do all charities pay the same rates?

Answer: According to the ACGA, some 96 percent usually or always follow their suggested rates. The ACGA meets periodically and sets recommended rates based on current investment returns and other factors.

Question: Are there laws or regulations that I should be aware of before offering charitable gift annuities?

Answer: A number of states also regulate and monitor the issuance of gift annuities to the residents of their states. See www.acga-web.org for a full listing of these states and other information. Also, the Philanthropy Protection Act of 1995 provides donor disclosure rules and other rules that should be followed for federal securities law purposes.

Question: Does the 10 percent minimum charitable remainder requirement included as part of the 1997 Tax Act for charitable remainder trusts apply to gift annuities? 

Answer: No. That rule applies only to charitable remainder trusts. However, a separate 10 percent minimum rule applies to charitable gift annuities.

Question: Is there more than one type of charitable gift annuity?

Answer: Actually, there are a variety of different types of gift annuities. The vast majority are of the immediate-payment type, but payments may also be deferred for a number of years, or even ended before the end of a payment recipient’s lifetime.

Question: Why have gift annuities become more popular in recent years?

Answer: The increase in the number of charities offering this gift option, the growth of the older population that receives “higher” payout rates and a relatively low interest rate environment have all contributed to their popularity. Gift annuities are particularly attractive to the growing number of individuals who are at or approaching retirement age. Some 70 million people are expected to enter this age range over the next two decades, another reason to anticipate even greater interest in this gift planning tool in coming years.

Many of the concepts and scenarios discussed in this article are drawn from Sharpe seminar presentations and publications such as “Giving Through Gift Annuities” and “Questions & Answers About Gift Annuities.” Click here  for the schedule of upcoming seminars and how to register. Or contact us at 901.680.5300, info@SHARPEnet.com. ■

The publisher of Give & Take is not engaged in rendering legal or tax advisory service. For advice and assistance in specific cases, the services of your own counsel should be obtained. Articles in Give & Take may generally be reprinted for distribution to board members and staff of nonprofit institutions and other non-donor groups. Proper credit must be given. Call for details.

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