How a Charitable Gift Annuity Can Be Advantageous to Federal Employees and Retirees with Sizeable Estates

A recent column discusses an IRA charitable gift annuity and how it can benefit traditional IRA owners with sizeable estates. Among the disadvantages of an IRA charitable gift annuity is the maximum one-time $50,000 maximum distribution from a traditional IRA to fund the annuity, fully taxable annuity income for the life of the donor, and no charitable tax deduction for donating the IRA funds to a qualified charity.

This column discusses the charitable gift annuity as a viable alternative to the IRA charitable gift annuity.

SEE ALSO: Using an IRA Charitable Gift Annuity to Make a Charitable Donation and Receive Income for Life

In order to fund a charitable gift annuity, an individual (called the “donor”) uses cash or appreciated securities rather than funds from a traditional IRA. Among the potential benefits of a non-IRA funded charitable gift annuity:

• A charitable income tax deduction if the donor itemizes on his or her federal income tax return

• Avoidance of some capital gains taxes, with any remaining capital gain taxes payable spread over the donor’s life expectancy

• Some tax-free income for the donor’s life expectancy

• No $50,000 donation limit

• Ability to include other annuity income beneficiaries, and

• An option to defer the start of payments to some later date resulting in larger monthly payments.

How a Charitable Gift Annuity Works

A charitable gift annuity is a contract between a donor and a charity under the following terms: The donor makes a sizeable gift to the charity using cash, securities such as stocks, bonds and mutual funds, and possibly other assets. In return, the donor receives a partial charitable tax deduction as a result of the donation, plus a fixed income stream for the rest of the donor’s life.

Many large nonprofit organizations (for example, the American Institute for Cancer Research) offer charitable gift annuities. When an individual who wants to establish a charitable gift annuity donates to a single charity, the donation is set aside by the charity in a reserve account and invested. Based on the donor’s age(s) at the time of the gift, the donor receives a fixed monthly or quarterly payment for the rest of the donor’s life. At the end of the donor’s (and spouse’s life, if married and setting up a “joint” charitable gift annuity) the charity keeps any funds remaining from the original donation.

Minimum donations for establishing a charitable gift annuity are as low as $5,000 but often are much larger. The larger the donation, the larger the monthly payment to the gift donor. The size of the payment is determined by many factors including the donor’s (and the donor’s spouse’s) age when the charitable gift annuity is set up. The payment is fixed and will never fluctuate or adjust for inflation. However, the payment is guaranteed backed by the charity’s entire assets – not just the donor’s donation, and will continue for the lives of the donors, no matter how well or poorly the annuity

Taxes and Charitable Gift Annuities

A charitable gift annuity owner (the donor) may be eligible to claim a partial charitable tax deduction for the year in which the charitable gift annuity is established.

The reason that the tax deduction is only partial is because the IRS views one portion of the funds contributed to the charity as a gift used immediately by the charity as part of its charitable purposes. The other portion of the contribution is viewed as an investment bringing monthly income to the donor.

A second tax benefit may come about by donating long-term (more than one year) held appreciated securities directly to the charity if the charity accepts these capital assets in place of cash. By donating appreciated property directly to the charity, it is possible to reduce or eliminate the capital gains tax a donor would pay had the donor sold the assets first and then donated the net proceeds to the charity.

The downside to making charitable gifts funded with cash and/or appreciated capital assets is that a portion of the annuity income is taxable at both the federal and state levels, depending on whether the state in which the donor lives has a state income tax.

However, a charitable gift annuity can be useful for those individuals whose estates are large enough resulting in possible federal estate and/or state estate tax liability when the individual dies.

If the donor has a large portfolio of appreciated securities such as stocks, stock mutual funds, bonds or exchange-traded funds, the donor is advised to gift the appreciated securities while the donor is living. An individual’s gifting to family members, such as children and grandchildren, over a period of time seems to be a sensible way to remove the appreciated assets from the donor’s estate.

The problem with gifting appreciated securities is that gift recipients take over the low “cost basis” of the donor, and when the gift recipients sell the appreciated assets, they could pay a sizeable amount of capital gains taxes. By donating the appreciated securities to a qualified charity via a charitable gift annuity, the charity pays no taxes when the appreciated securities are sold.

Most importantly, the donor benefits as follows:

(1) Receives a lifetime annuity;

(2) In the year of donation, the donor gets a charitable deduction; and

(3) the donated assets are removed from the donor’s estate, thereby minimizing the possibility that the donor’s estate will be subject to federal estate and/or state estate taxes.

Charitable Gift Annuity Interest Rates

Charitable gift annuity interest rates are typically lower than noncharitable annuity interest rates such as fixed annuity interest rates offered by private insurance companies. Rates vary according to the donor’s age and the charity. Many nonprofit organizations use interest rates recommended by the American Council on Gift Annuities (ACGA).

For example, a 60-year-old who donates $10,000 to a charity via a charitable gift annuity may receive an interest rate of 4.4 percent, thereby receiving $440 annually, while an 85-year-old who donates $10,000 to a charity via a charitable gift annuity will get an interest rate of 7.8 percent, thereby receiving $780 annually.

Some charities offer higher interest rates for donors who agree to wait a number of years before starting to receive payments in what is called deferred charitable gift annuity.

The following example illustrates the financial and tax features of a $50,000 charitable gift annuity funded with cash:

Assumptions: Donor’s age – 74
Donor’s federal marginal tax bracket – 24 percent
Annuity interest rate – 6.4 percent

Results:

¹ Actuarially determined using a 5 percent Internal Revenue Code 7520 interest rate used to value the charitable interest.
² Calculated as follows: $50,000 cash donation less $21,882 divided by 13.1-year life expectancy of a 74-year-old donor.
³ $3,200 less $2,147.

Potential Advantages of a Charitable Gift Annuity

• Income stream for the donor’s life via a fixed annuity

• Immediate partial tax deduction based on the donor’s life expectancy and anticipated income stream

• Portion of the income stream is tax-free

• Donor can gift several types of capital assets including cash, securities and personal property

• Reduced or eliminated capital gains tax liability for gifts of appreciated capital assets and personal property, and

• Reducing the size of the gross estate which could result in reduced or no federal estate or state estate tax liability at the death of the donor.

Potential Disadvantages of a Charitable Gift Annuity

• Parting irrevocably with assets donated to create the annuity

• A portion of the annuity payments are taxable

• Annuity payments are fixed and are not adjusted for inflation, and

• Annuity payments are usually lower than with a non-charitable annuity because the primary purpose of purchasing a charitable gift annuity is to support a charitable organization.