Planning Matters | Sharpe Group
Posted December 1st, 2004

Planning Matters

In recent years, a growing number of charities have begun to offer charitable gift annuities to their donors. According to a survey conducted by the American Council on Gift Annuities, over one-half of the charities issuing gift annuities in 1999 had been doing so for fewer than 10 years and nearly one-third had started their program within the past five years. Most planned giving experts would agree that charitable gift annuities are one of the most popular planned giving techniques. In fact, they are no doubt second only to charitable bequests in the number of individual planned gift transactions. This month’s “Planning Matters” is devoted to some common questions about charitable gift annuities.

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 generally based upon the donor’s age. It is set with the goal in mind of providing the charity with 50% 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 40% to 50% of the amount transferred.

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

Answer: The answer depends upon 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.

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 another person other than a spouse receives payments from the annuity following the donor’s death.

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 $1,700 (6.8% of the amount transferred) would be divided between a taxable and non-taxable portion for a number of 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 $213.17
Capital Gain $852.73
Ordinary Income $634.10

If the annuity were funded with cash, the tax-free component would be increased. 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 over $10,000. 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 annuity payments, the amount used to fund her gift annuity would not be part of her estate.

Question: Do all charities pay the same rate?

Answer: According to the American Council on Gift Annuities (ACGA), some 97% usually or always follow the rates suggested by that organization. The ACGA meets periodically and sets recommended rates based on current investment returns and other factors.

Question: Doesn’t that violate antitrust law or regulations?

Answer: In 1995, Congress acted to exempt gift annuities from antitrust regulation on the basis that gift annuities were primarily gift transactions and the recommended rates served to protect the interests of both charities and their donors.

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

Answer: In addition to the 1995 antitrust legislation, Congress also passed the Philanthropy Protection Act (PPA) that year. The PPA exempted gift annuities and certain other planned gifts from securities registration requirements but set out certain other guidelines. These included a prohibition against payment of commissions in connection with marketing gift annuities, requirements that donors be given a written disclosure statement prior to completing a gift annuity, and provisions that made it clear that antifraud regulations applied to the marketing of gift annuities. A growing number of states also regulate and monitor the issuance of gift annuities to the residents of their states. See for a full listing of these states and other information.

Question: Does the 10% minimum charitable remainder rule promulgated in the 1997 Tax Act for charitable remainder trusts apply to gift annuities?

Answer: No. That rule only applies to charitable remainder trusts. However, a separate 10% 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 commuted at a later date.

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

Answer: The increase in the number of charities offering these contracts, the growth of the older population that receives “higher” payout rates, and a low interest rate environment have all contributed to their popularity. Gift annuities are particularly attractive to the growing number of healthy, active individuals that are 70 or older. Some 70 million persons are expected to enter this age range over the next two decades, another reason for the increased popularity of this plan among charities.

Editor’s note: Many of the concepts and scenarios discussed in this article are drawn from Sharpe seminar presentations and publications such as “Questions & Answers About Gift Annuities.”

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