by Robert Blizard for Wealth Strategies Journal
Perhaps you've tinkered with the idea of funding a charitable gift annuity (CGA). Or maybe you've just wanted to learn more about them. But, for some reason, you've held back.
You know a little bit about them. They're offered by 501(c)(3) charities, typically for people in their retirement years. The rates are age-based, such that the older the beneficiary or beneficiaries (there can be no more than two) of the annuity, the higher the rate. They're relatively safe, fixed-payment vehicles that constitute irrevocable donations to the nonprofit. Basically, they further charitable causes while also providing supplemental lifetime cash flow on a periodic basis, often through direct-deposit.
Although some investment advisors may pooh-pooh CGAs, they may not realize that the CGA rate is a nominal return and the effective return is higher, given this vehicle's tax benefits. Moreover, a gift annuity can be structured a number of different ways to match a donor's financial goals and limitations. Once the donor has consulted with her legal and financial advisors to determine that a gift annuity would be appropriate, the process of setting one up is quite simple. It usually requires only the completion of a brief application, verification of the age(s) of the beneficiary(ies), and signatures on a one- or two-page contract.
So, there is much to know about these instruments, which are offered by a number of charities. You may have even heard public radio promoting them as you drove to work or seen them advertised in your favorite charity's newsletter with a rate chart and a photo of a healthy-looking, all-American elderly couple. Anyone who gives to charity and is over 65 is surely receiving information about them in his mailbox.
Lumped under the heading of "planned giving"--to distinguish it from realized-in-the-current-year gifts to a charity's annual fund--a CGA is, at once, both popular and obscure. Simple and, simultaneously, a little complex.
In an effort to help you understand more about charitable gift annuities, I have written a facsimile of a short oral presentation I gave to the Elder Law and Trusts and Estates sections of the Fairfax (VA) Bar Association last year.
The goal of the presentation was to show everyone a basic "vanilla" scenario for a gift annuity and then show a variety of alternate examples with only one variable changed. This one change illuminates the effect on payouts and taxes driven by one variable. Such knowledge may be helpful in planning a more optimal financial solution for you--and providing a larger gift to the nonprofit of your choice.
LET'S START AT THE VERY BEGINNING...
A very good place to start! Remember Julie Andrews playing that guitar on top of an Alp while teaching the Von Trapp children how to sing? Like "Do Re Mi," the starting point for looking at different CGA scenarios is a basic version. For this first sample scenario, I am using a charitable gift annuity for a beneficiary age 70 making a $10,000 gift in the form of cash, with the beneficiary beginning to receive payments in the current quarter.
Please note that the donor need not be the beneficiary; a 45-year-old daughter, for example, could fund a gift annuity for her 70-year-old mother, like the 70-year-old in the example below. Or a deceased person's will could direct a contribution to a nonprofit for the purpose of establishing a CGA for a survivor.
If the donor is not the beneficiary, keep in mind that some of the annuity's features (stream of payments) pertain only to the beneficiary and others (the charitable contribution amount for a potential tax deduction) pertain only to the donor. For simplicity's sake, this article assumes that the donor and the beneficiary are the same.
One other note as we get started. I have developed all of the scenarios with a gift date of May 1, 2009 and used the rates recommended by the American Council of Gift Annuities (ACGA) for use starting on February 1, 2009. Those rates can be found online at acga-web.org. The vast majority of charities adhere to the ACGA's rates to ensure that both the nonprofit and the donor benefit from the CGA.
The beauty of most charities adopting the ACGA rates is its intended effect: organizations are discouraged from raising annuity rates to compete for donor dollars. Instead, the donor can shop for a mission she likes most, or for an organization she thinks is managed well, rather than shopping for a higher rate. That way, charities do not encumber themselves with unnecessarily large liabilities and they compete on as even a playing field as possible.
Rates are computed by the ACGA using actuarial, investment and cost data and are reviewed at least annually. A review does not always result in any change. That said, rates have declined twice since the spring of 2008 to reflect the declining economy and the ACGA is in the process of reviewing them once again. But as soon as a donor and a charity contract together for an annuity, the rate is fixed--no matter what happens to the ACGA rates thereafter.
MMM...VANILLA
With this understanding, here is the vanilla scenario promised above. Notice that at age 70, there is a charitable contribution amount of about one-third of the donation. The remaining amount is the present value of the annuity payments to be made over time. Actuarially, this donor is expected to live for 15.9 more years, almost until age 86. At that point, the donor has reached his statistical life expectancy, and his payments that were previously tax-free in part become all ordinary income.
The greater the donation to fund the annuity, the more the annuity benefits increase proportionally. In the scenario below, a gift that is twice as large funds an annuity with twice the annual payout and twice the charitable contribution.
In this scenario below, as with all of the illustrations in this article, only the differences from the original vanilla scenario are printed in red. Note that the vanilla example remains exactly the same throughout this article, no matter to which differing scenario it is being compared.
If the gift were half as large, the annuity benefits would be 50% less than in the vanilla scenario.
In most cases, if the donor is older, both the annuity rate and the charitable contribution amount increase. For example, in the comparison of illustrations below, if the donor were 75 instead of 70, the rate jumps from 5.7% to 6.3% and the potential tax deduction goes up almost $600. Note also, however, that as the donor ages, the number of years that partially tax-free payments are received decreases. This is because a CGA's partially tax-free period lasts through a donor's actuarial life expectancy, computed as of the time that payments begin.
ACGA rates top out at 9.5% for someone age 90 and above, although just a year ago this rate was more than 11%.
DIFFERENT ANNUITY RATES
When the ACGA recommends a different set of rates, the rate changes will affect not only the amount paid, but also the tax benefits a donor will receive.
Sometimes charities ask donors if they would consider taking an annuity rate less than the ACGA recommended rate as a charitable gesture that reduces the nonprofit's liability. Sometimes, donors do this voluntarily. Terrific for the nonprofit--and the IRS rewards the donor with a higher charitable contribution if the donor is willing to accept a lower rate, thus acknowledging the donor's greater charitable intent.
The scenario below shows the effect of a lower CGA rate and the inverse correlation between the charitable portion of the annuity and the payout rate. As the rate below drops a full percent from the vanilla scenario, the charitable contribution jumps significantly--by more than $1,000!
Although unlikely in this economy, there is always the chance that ACGA rates, which somewhat reflect the health of the economy at large, will rise and that a charity could pay the donor of a new CGA more; however, it is unlikely that many charities would pay a rate higher than the applicable ACGA rate for any reason. That said, there are some nonprofits that regularly pay annuity rates above the ACGA rates and that advertise them heavily, probably attracting many donors who have little or no charitable interest in the organization. Most charities prefer to be conservative, prudent fiduciaries, meaning that very few of them will offer annuities for rates above those suggested by the ACGA rates--especially in times when the invested annuity reserves are getting less-than-stellar returns in a volatile market.
ADDITIONAL BENEFICIARY
One of the great features of CGAs is that two people can be beneficiaries of the same annuity. And they need not be married or related in any way. This is beneficial for, say, two siblings or domestic partners who want to provide for each other in retirement. However, adding a second beneficiary does affect the age-based rate by, unfortunately, always bringing it down--even if the second beneficiary is older.
This drop occurs because the rates are based on actuarial data and it is more likely that at least one of the two beneficiaries will be alive at any given time, thus tending to cost the charity more to fulfill the annuity's terms than if there were only one beneficiary.
In the case below, a second annuitant of the same age drops the rate for a 70-year-old beneficiary in the vanilla scenario by half a percent. (Note that a beneficiary's age becomes one year greater if that beneficiary is within six months of her next birthday.)
Also, notice the charitable contribution amount drops by more than $1,000, although this difference is offset by the fact that the total amount paid on a tax-free basis over the 20.5-year combined life expectancy is correspondingly larger than the tax-free amount paid over the 15.9-year life expectancy associated with a single beneficiary.
As noted above, even if the second annuitant is older, the rate on the annuity is lower than for just one person in the vanilla scenario.
If the second annuitant is five years younger than the first, the rate and charitable contribution amount plummet from the corresponding amounts for the annuity with just one beneficiary in the vanilla scenario. Notice, however, for how many more years the beneficiaries receive partially tax-free payments.
CHANGES IN DISCOUNT RATE
The IRS discount rate--also known as the Applicable Federal Rate--is a figure released monthly for the purpose of determining charitable contributions and other tax aspects for some forms of planned gifts. The rate is essentially a proxy for what a donation will earn over the duration of the gift arrangement. Indeed, the rate is a reflection of what is happening in the marketplace and it recently hit an all-time low of 2.0% in February 2009.
You can think of the IRS discount rate a little bit like an opportunity cost, to borrow a term from Economics 101. In the context of a CGA, the higher the rate, the more financial return the donor is foregoing by making the donation, and, therefore, the greater the charitable intent of the donor and the greater her potential tax deduction. A change in the discount rate alters the tax effect of the gift--but never affects the annuity rate or the annual payout amount.
This scenario and all the others were developed with a gift date of May 1, 2009, but the law allows a donor to use either the IRS discount rate for the month in which a gift is made or the rate associated with one of the two immediately preceding months. So, in the case of the vanilla scenario and all others up to now, I have used the 2.6% rate from April 2009, because the rate in both March 2009 and May 2009 was lower than April's at 2.4%. As mentioned in the immediately preceding paragraph, the higher the IRS discount rate, the higher the charitable contribution.
For the illustration below, however, I have used the May (and March) 2009 rate of 2.4%. Note how the lower discount rate drops the charitable contribution amount, but increases the portion of the annual payout that is tax-free. The annuity rate, meanwhile, stays the same.
The next scenario assumes the discount rate is 3.4%, a full point higher than the 2.4% May 2009 rate. You will see that when the discount rate increases, the charitable contribution amount increases. On the other hand, the portion of the annual payout that is tax-free declines.
Again, regardless of the discount rate's movement, the annuity rate remains unchanged. Such is the relationship of ACGA annuity rates, which remain relatively stable and are recommended by a private nonprofit, and the IRS discount rates, which are determined by the federal government, are subject to change monthly, and more strongly reflect the economy's volatility.
FUNDING WITH SECURITIES AND OTHER ASSETS
The previous illustrations have showed donations made with cash. However, a donor can fund a charitable gift annuity with stock or other securities, such as bonds and mutual fund shares. The greater the appreciation of any long-term securities donated for the annuity, the more capital gains that are avoided and thus the better the tax benefit for the donor. Whereas a donor completely eliminates her need to recognize capital gains when she donates appreciated stock or securities as an outright gift, capital gains are not eliminated altogether when the asset funds a gift annuity. But they are significantly reduced and--so long as the donor is also either the sole beneficiary or the initial beneficiary--amortized over a number of years, rather than recognized all at once, as would be the case if the asset were sold.
In the scenario below, the stock was purchased for $5,000 but is now worth $10,000. Note that the only change from the vanilla scenario is that the portion of the annuity that was tax-free is now divided into tax-free and capital gain components. In this case, the ratio of the tax-free portion to the capital gain portion is one to one because the stock had appreciated by 100%. Had the stock appreciated by only 50%, the ratio of the tax-free portion to the capital gain portion would have been two to one. Note also that the donor has 15.9 years to report the capital gain--the same time period during which his income will be partially tax-free and the number of years he is expected to live.
Furthermore--and this may unfortunately be all too relevant at this time--securities need not be appreciated to fund a gift annuity. Nevertheless, a donor considering using such securities would do better from a tax standpoint to sell them first (thereby recognizing a capital loss) and then donate the resulting cash.
Donors can also fund gift annuities with other types of assets of significant value. These can include real estate, artwork, or jewelry, although in the case of some of these assets, the tax results will be different from those associated with donating long-term appreciated securities.
DEFERRED PAYMENTS
A donor can always elect for himself or another beneficiary to begin receiving payments at some later date, which must be more than one year in the future. Why would anyone take such a step?
Perhaps the donor plans to continue working for the next five years and feels comfortable with his current level of income, so he decides to defer payments for those five years. In exchange, the donor receives tax benefits for his willingness to forego payments and to risk receiving no payments at all, should he pass away in the interim.
Notice the significantly larger tax benefit to the donor and the increase in payments to the beneficiary. Be aware, however, that when the IRS discount rate is relatively low, as it has been recently, the tax aspects may not be all that attractive for younger beneficiaries, such as those in their fifties whose payments are deferred until they are in their sixties. Still, for a beneficiary of any age, the longer the deferral period, the greater the amount paid once the deferral period ends.
If a donor wants to defer annuity payments to reap financial benefits but does not know how long she wishes to defer, there is a flexible deferred gift annuity to help her out. In this case, the donor simply informs the charity of her uncertainty when funding the annuity. The charity then provides the donor with an instrument that features deferred payments but postpones the choice of a starting date. Nevertheless, the donor must settle on a range of possible years in which the payments would begin, and the charitable contribution to which she will be entitled will be the one that is smallest for any of the years in the range; typically, this will be the one associated with the first year.
Another option that exists with respect to a deferred annuity permits the beneficiary to elect before payments begin to have the future stream of lifetime payments starting on a given date be commuted into a future series of payments made over a fixed number of years starting on the same date. This does not change the charitable contribution, but it does increase considerably the amount paid each year over the term of years selected while also altering the portion of each payment that is tax-free.
Often, the period that is selected is four years because these annuities can be used by grandparents, for example, to provide payments for college students during the four years they would normally be studying, rather than working full-time. But the period need not be four years.
A NOTE THAT BRINGS US BACK TO "DO"
Obviously, there are a number of ways that a donor and a charity can arrange a gift annuity scenario. The number may not quite reach 31--but vanilla is not the only flavor, as this assortment of annuity examples demonstrates.
And all of this financial scenario-hopping is certainly not The Sound of Music. Indeed, it may not be as exciting as a singing nun-cum-governess flying through Salzburg on a bicycle while belting out kiddie tunes. But, consider that knowing more about CGAs might be just as important as singing when it comes to planning your estate. If not a wee bit more!
Rob Blizard serves as the planned giving director for George Washington's Mount Vernon in Mount Vernon, VA. He also writes freelance articles for a variety of publications. You can reach him at 703-799-8652 and rblizard@mountvernon.org. More information on CGAs appears online on the Mount Vernon website at mountvernon.org/annuity.
The author would like to express appreciation for assistance with this article received from Bill Zook, Vice President and Director of the Seattle office of PG Calc, a Cambridge, MA-based firm that provides charitable gift planning products and services to thousands of charitable organizations nationwide.
Perhaps you've tinkered with the idea of funding a charitable gift annuity (CGA). Or maybe you've just wanted to learn more about them. But, for some reason, you've held back.
You know a little bit about them. They're offered by 501(c)(3) charities, typically for people in their retirement years. The rates are age-based, such that the older the beneficiary or beneficiaries (there can be no more than two) of the annuity, the higher the rate. They're relatively safe, fixed-payment vehicles that constitute irrevocable donations to the nonprofit. Basically, they further charitable causes while also providing supplemental lifetime cash flow on a periodic basis, often through direct-deposit.
Although some investment advisors may pooh-pooh CGAs, they may not realize that the CGA rate is a nominal return and the effective return is higher, given this vehicle's tax benefits. Moreover, a gift annuity can be structured a number of different ways to match a donor's financial goals and limitations. Once the donor has consulted with her legal and financial advisors to determine that a gift annuity would be appropriate, the process of setting one up is quite simple. It usually requires only the completion of a brief application, verification of the age(s) of the beneficiary(ies), and signatures on a one- or two-page contract.
So, there is much to know about these instruments, which are offered by a number of charities. You may have even heard public radio promoting them as you drove to work or seen them advertised in your favorite charity's newsletter with a rate chart and a photo of a healthy-looking, all-American elderly couple. Anyone who gives to charity and is over 65 is surely receiving information about them in his mailbox.
Lumped under the heading of "planned giving"--to distinguish it from realized-in-the-current-year gifts to a charity's annual fund--a CGA is, at once, both popular and obscure. Simple and, simultaneously, a little complex.
In an effort to help you understand more about charitable gift annuities, I have written a facsimile of a short oral presentation I gave to the Elder Law and Trusts and Estates sections of the Fairfax (VA) Bar Association last year.
The goal of the presentation was to show everyone a basic "vanilla" scenario for a gift annuity and then show a variety of alternate examples with only one variable changed. This one change illuminates the effect on payouts and taxes driven by one variable. Such knowledge may be helpful in planning a more optimal financial solution for you--and providing a larger gift to the nonprofit of your choice.
LET'S START AT THE VERY BEGINNING...
A very good place to start! Remember Julie Andrews playing that guitar on top of an Alp while teaching the Von Trapp children how to sing? Like "Do Re Mi," the starting point for looking at different CGA scenarios is a basic version. For this first sample scenario, I am using a charitable gift annuity for a beneficiary age 70 making a $10,000 gift in the form of cash, with the beneficiary beginning to receive payments in the current quarter.
Please note that the donor need not be the beneficiary; a 45-year-old daughter, for example, could fund a gift annuity for her 70-year-old mother, like the 70-year-old in the example below. Or a deceased person's will could direct a contribution to a nonprofit for the purpose of establishing a CGA for a survivor.
If the donor is not the beneficiary, keep in mind that some of the annuity's features (stream of payments) pertain only to the beneficiary and others (the charitable contribution amount for a potential tax deduction) pertain only to the donor. For simplicity's sake, this article assumes that the donor and the beneficiary are the same.
One other note as we get started. I have developed all of the scenarios with a gift date of May 1, 2009 and used the rates recommended by the American Council of Gift Annuities (ACGA) for use starting on February 1, 2009. Those rates can be found online at acga-web.org. The vast majority of charities adhere to the ACGA's rates to ensure that both the nonprofit and the donor benefit from the CGA.
The beauty of most charities adopting the ACGA rates is its intended effect: organizations are discouraged from raising annuity rates to compete for donor dollars. Instead, the donor can shop for a mission she likes most, or for an organization she thinks is managed well, rather than shopping for a higher rate. That way, charities do not encumber themselves with unnecessarily large liabilities and they compete on as even a playing field as possible.
Rates are computed by the ACGA using actuarial, investment and cost data and are reviewed at least annually. A review does not always result in any change. That said, rates have declined twice since the spring of 2008 to reflect the declining economy and the ACGA is in the process of reviewing them once again. But as soon as a donor and a charity contract together for an annuity, the rate is fixed--no matter what happens to the ACGA rates thereafter.
MMM...VANILLA
With this understanding, here is the vanilla scenario promised above. Notice that at age 70, there is a charitable contribution amount of about one-third of the donation. The remaining amount is the present value of the annuity payments to be made over time. Actuarially, this donor is expected to live for 15.9 more years, almost until age 86. At that point, the donor has reached his statistical life expectancy, and his payments that were previously tax-free in part become all ordinary income.
The greater the donation to fund the annuity, the more the annuity benefits increase proportionally. In the scenario below, a gift that is twice as large funds an annuity with twice the annual payout and twice the charitable contribution.
In this scenario below, as with all of the illustrations in this article, only the differences from the original vanilla scenario are printed in red. Note that the vanilla example remains exactly the same throughout this article, no matter to which differing scenario it is being compared.
If the gift were half as large, the annuity benefits would be 50% less than in the vanilla scenario.In most cases, if the donor is older, both the annuity rate and the charitable contribution amount increase. For example, in the comparison of illustrations below, if the donor were 75 instead of 70, the rate jumps from 5.7% to 6.3% and the potential tax deduction goes up almost $600. Note also, however, that as the donor ages, the number of years that partially tax-free payments are received decreases. This is because a CGA's partially tax-free period lasts through a donor's actuarial life expectancy, computed as of the time that payments begin.
ACGA rates top out at 9.5% for someone age 90 and above, although just a year ago this rate was more than 11%.
DIFFERENT ANNUITY RATES
When the ACGA recommends a different set of rates, the rate changes will affect not only the amount paid, but also the tax benefits a donor will receive.
Sometimes charities ask donors if they would consider taking an annuity rate less than the ACGA recommended rate as a charitable gesture that reduces the nonprofit's liability. Sometimes, donors do this voluntarily. Terrific for the nonprofit--and the IRS rewards the donor with a higher charitable contribution if the donor is willing to accept a lower rate, thus acknowledging the donor's greater charitable intent.
The scenario below shows the effect of a lower CGA rate and the inverse correlation between the charitable portion of the annuity and the payout rate. As the rate below drops a full percent from the vanilla scenario, the charitable contribution jumps significantly--by more than $1,000!
Although unlikely in this economy, there is always the chance that ACGA rates, which somewhat reflect the health of the economy at large, will rise and that a charity could pay the donor of a new CGA more; however, it is unlikely that many charities would pay a rate higher than the applicable ACGA rate for any reason. That said, there are some nonprofits that regularly pay annuity rates above the ACGA rates and that advertise them heavily, probably attracting many donors who have little or no charitable interest in the organization. Most charities prefer to be conservative, prudent fiduciaries, meaning that very few of them will offer annuities for rates above those suggested by the ACGA rates--especially in times when the invested annuity reserves are getting less-than-stellar returns in a volatile market.ADDITIONAL BENEFICIARY
One of the great features of CGAs is that two people can be beneficiaries of the same annuity. And they need not be married or related in any way. This is beneficial for, say, two siblings or domestic partners who want to provide for each other in retirement. However, adding a second beneficiary does affect the age-based rate by, unfortunately, always bringing it down--even if the second beneficiary is older.
This drop occurs because the rates are based on actuarial data and it is more likely that at least one of the two beneficiaries will be alive at any given time, thus tending to cost the charity more to fulfill the annuity's terms than if there were only one beneficiary.
In the case below, a second annuitant of the same age drops the rate for a 70-year-old beneficiary in the vanilla scenario by half a percent. (Note that a beneficiary's age becomes one year greater if that beneficiary is within six months of her next birthday.)
Also, notice the charitable contribution amount drops by more than $1,000, although this difference is offset by the fact that the total amount paid on a tax-free basis over the 20.5-year combined life expectancy is correspondingly larger than the tax-free amount paid over the 15.9-year life expectancy associated with a single beneficiary.
As noted above, even if the second annuitant is older, the rate on the annuity is lower than for just one person in the vanilla scenario. If the second annuitant is five years younger than the first, the rate and charitable contribution amount plummet from the corresponding amounts for the annuity with just one beneficiary in the vanilla scenario. Notice, however, for how many more years the beneficiaries receive partially tax-free payments.CHANGES IN DISCOUNT RATEThe IRS discount rate--also known as the Applicable Federal Rate--is a figure released monthly for the purpose of determining charitable contributions and other tax aspects for some forms of planned gifts. The rate is essentially a proxy for what a donation will earn over the duration of the gift arrangement. Indeed, the rate is a reflection of what is happening in the marketplace and it recently hit an all-time low of 2.0% in February 2009.
You can think of the IRS discount rate a little bit like an opportunity cost, to borrow a term from Economics 101. In the context of a CGA, the higher the rate, the more financial return the donor is foregoing by making the donation, and, therefore, the greater the charitable intent of the donor and the greater her potential tax deduction. A change in the discount rate alters the tax effect of the gift--but never affects the annuity rate or the annual payout amount.
This scenario and all the others were developed with a gift date of May 1, 2009, but the law allows a donor to use either the IRS discount rate for the month in which a gift is made or the rate associated with one of the two immediately preceding months. So, in the case of the vanilla scenario and all others up to now, I have used the 2.6% rate from April 2009, because the rate in both March 2009 and May 2009 was lower than April's at 2.4%. As mentioned in the immediately preceding paragraph, the higher the IRS discount rate, the higher the charitable contribution.
For the illustration below, however, I have used the May (and March) 2009 rate of 2.4%. Note how the lower discount rate drops the charitable contribution amount, but increases the portion of the annual payout that is tax-free. The annuity rate, meanwhile, stays the same.
The next scenario assumes the discount rate is 3.4%, a full point higher than the 2.4% May 2009 rate. You will see that when the discount rate increases, the charitable contribution amount increases. On the other hand, the portion of the annual payout that is tax-free declines. Again, regardless of the discount rate's movement, the annuity rate remains unchanged. Such is the relationship of ACGA annuity rates, which remain relatively stable and are recommended by a private nonprofit, and the IRS discount rates, which are determined by the federal government, are subject to change monthly, and more strongly reflect the economy's volatility.FUNDING WITH SECURITIES AND OTHER ASSETS
The previous illustrations have showed donations made with cash. However, a donor can fund a charitable gift annuity with stock or other securities, such as bonds and mutual fund shares. The greater the appreciation of any long-term securities donated for the annuity, the more capital gains that are avoided and thus the better the tax benefit for the donor. Whereas a donor completely eliminates her need to recognize capital gains when she donates appreciated stock or securities as an outright gift, capital gains are not eliminated altogether when the asset funds a gift annuity. But they are significantly reduced and--so long as the donor is also either the sole beneficiary or the initial beneficiary--amortized over a number of years, rather than recognized all at once, as would be the case if the asset were sold.
In the scenario below, the stock was purchased for $5,000 but is now worth $10,000. Note that the only change from the vanilla scenario is that the portion of the annuity that was tax-free is now divided into tax-free and capital gain components. In this case, the ratio of the tax-free portion to the capital gain portion is one to one because the stock had appreciated by 100%. Had the stock appreciated by only 50%, the ratio of the tax-free portion to the capital gain portion would have been two to one. Note also that the donor has 15.9 years to report the capital gain--the same time period during which his income will be partially tax-free and the number of years he is expected to live.
Furthermore--and this may unfortunately be all too relevant at this time--securities need not be appreciated to fund a gift annuity. Nevertheless, a donor considering using such securities would do better from a tax standpoint to sell them first (thereby recognizing a capital loss) and then donate the resulting cash.Donors can also fund gift annuities with other types of assets of significant value. These can include real estate, artwork, or jewelry, although in the case of some of these assets, the tax results will be different from those associated with donating long-term appreciated securities.
DEFERRED PAYMENTS
A donor can always elect for himself or another beneficiary to begin receiving payments at some later date, which must be more than one year in the future. Why would anyone take such a step?
Perhaps the donor plans to continue working for the next five years and feels comfortable with his current level of income, so he decides to defer payments for those five years. In exchange, the donor receives tax benefits for his willingness to forego payments and to risk receiving no payments at all, should he pass away in the interim.
Notice the significantly larger tax benefit to the donor and the increase in payments to the beneficiary. Be aware, however, that when the IRS discount rate is relatively low, as it has been recently, the tax aspects may not be all that attractive for younger beneficiaries, such as those in their fifties whose payments are deferred until they are in their sixties. Still, for a beneficiary of any age, the longer the deferral period, the greater the amount paid once the deferral period ends.
If a donor wants to defer annuity payments to reap financial benefits but does not know how long she wishes to defer, there is a flexible deferred gift annuity to help her out. In this case, the donor simply informs the charity of her uncertainty when funding the annuity. The charity then provides the donor with an instrument that features deferred payments but postpones the choice of a starting date. Nevertheless, the donor must settle on a range of possible years in which the payments would begin, and the charitable contribution to which she will be entitled will be the one that is smallest for any of the years in the range; typically, this will be the one associated with the first year.
Another option that exists with respect to a deferred annuity permits the beneficiary to elect before payments begin to have the future stream of lifetime payments starting on a given date be commuted into a future series of payments made over a fixed number of years starting on the same date. This does not change the charitable contribution, but it does increase considerably the amount paid each year over the term of years selected while also altering the portion of each payment that is tax-free.
Often, the period that is selected is four years because these annuities can be used by grandparents, for example, to provide payments for college students during the four years they would normally be studying, rather than working full-time. But the period need not be four years.
A NOTE THAT BRINGS US BACK TO "DO"
Obviously, there are a number of ways that a donor and a charity can arrange a gift annuity scenario. The number may not quite reach 31--but vanilla is not the only flavor, as this assortment of annuity examples demonstrates.
And all of this financial scenario-hopping is certainly not The Sound of Music. Indeed, it may not be as exciting as a singing nun-cum-governess flying through Salzburg on a bicycle while belting out kiddie tunes. But, consider that knowing more about CGAs might be just as important as singing when it comes to planning your estate. If not a wee bit more!
Rob Blizard serves as the planned giving director for George Washington's Mount Vernon in Mount Vernon, VA. He also writes freelance articles for a variety of publications. You can reach him at 703-799-8652 and rblizard@mountvernon.org. More information on CGAs appears online on the Mount Vernon website at mountvernon.org/annuity.
The author would like to express appreciation for assistance with this article received from Bill Zook, Vice President and Director of the Seattle office of PG Calc, a Cambridge, MA-based firm that provides charitable gift planning products and services to thousands of charitable organizations nationwide.
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