Charitable Gift Annuities Kara Morin, Managing Director, Harvard University Planned Giving

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1 Charitable Gift Annuities Kara Morin, Managing Director, Harvard University Planned Giving Give the tree, keep the fruit. Anne Melvin Donor has an apple tree that every year produces four bushels of apples. Planned Giving Group of New England 1

2 Year 1 Donor gives the apple tree in exchange for an immediate payment charitable gift annuity (CGA). Under the terms of the CGA, the donor receives four bushels of apples annually for life. Year 2 Bumper crop year! The apple tree produces 6 bushels of apples. Year 2 Donor receives 4 bushels of apples, in accordance with the CGA contract. Charity retains the two extra bushels. Planned Giving Group of New England 2

3 Year 3 Drought! The tree produces only two bushels of apples. But contract is for four bushels of apples for life. Year 3 Charity must make up the shortfall so that donor continues to receive four bushels. What is a Charitable Gift Annuity? Bargain sale Direct obligation of the charity Provides fixed income for life to a maximum of two persons. Income is not dependent on the performance of the principal A vehicle designed to preserve 50% of the value of the gift for the charity. Planned Giving Group of New England 3

4 The Bargain Sale in a Nutshell: Donor has a gold bar worth $10,000 Donor sells the gold bar to charity for $5,000. Donor receives an income tax deduction for $5,000. Charity sells the gold bar for $10,000 and nets $5,000. The Charitable Gift Annuity as a Bargain Sale Donor has $10,000 in cash. Donor sells (gives) the cash to charity in exchange for a stream of income for life. The IRS estimates that the present value of this stream of income is $5,000. Donor receives a deduction of $5,000. How to Charitable Gift Annuities Work? (Sole Donor/Sole Beneficiary Scenario) 1. Donor makes a gift to charity in exchange for an annuity. Donor can give cash or (practically) anything that can be liquidated for cash (the charity should have policies in place for non cash gifts). Cash Real Estate Marketable Securities Art and Collectibles Planned Giving Group of New England 4

5 How Do Charitable Gift Annuities Work? 2. Donor receives fixed income for life. This may be paid annually, quarterly or monthly. Most charities use the American Council of Gift Annuities (ACGA) recommended rates when issuing CGAs. ACGA rates are designed to preserve 50% of the value of the gift based on the life expectancy of the beneficiaries. Some charities have their own rates (ie. Harvard, Pomona). Whatever rate a charity chooses, it must meet the 10% test (the charitable deduction for the value of the gift must exceed 10% of the value of the amount given). How Do Charitable Gift Annuities Work? 3. Donor receives an income tax deduction. Deduction = Amount given Present Value (PV) of the beneficiaries annuity income per life expectancy How do we get to PV? The discount rate changes every month and the donor can choose the highest from the month of the gift and the two previous months. The higher the discount rate is, the higher the deduction. Historically rates have ranged from 11.6% to 1%. How Do Charitable Gift Annuities Work? 4. At the end of the donor s life, what is left of the principal is released to the charity for the charitable purpose stated in the gift annuity contract. Some charities require that life income gifts be for unrestricted purposes. Some charities require that life income gifts be added to endowment. Often the opportunity to name something with an annuity depends on the value of the deduction not the book value of the gift. Planned Giving Group of New England 5

6 Additional Benefits for CGA Donors In addition to an income tax deduction, the donor is taxed favorably on the annuity income. Gifts of cash result in an annuity that blends tax free and ordinary income for a term of years. Tax free income is return of principal. Gifts of appreciated assets result in an annuity that blends tax free, capital gain, and ordinary income for a term of years. Exact blend and length of the term depends on the nature of the asset given, and the life expectancy of the beneficiaries. Sample CGA Calculations 72 year old donor gives a gift of $10,000 cash in exchange for a 5.4% annuity ($540). BREAKDOWN OF ANNUITY: Tax free Ordinary Total 2018 to to onward After 14.5 years, the entire annuity becomes ordinary income. Sample CGA Calculations 72 year old donor gives a gift of $10,000 in marketable securities with a basis of $5,000 in exchange for a 5.4% annuity ($540). BREAKDOWN OF ANNUITY: Capital Tax free Ordinary Total Gain Portion Income Annuity 2017 to to to onward Total reportable capital gain of $2, must be reported over 14.5 years. After 14.5 years all income is ordinary. Planned Giving Group of New England 6

7 Three more gift annuity flavors for your donors to consider Deferred Gift Annuity Flexible Gift Annuity Stepped Gift Annuity Deferred Gift Annuity Donor makes a gift now, but defers first income for a term of years. Because they defer the income, they earn a higher rate and a higher income tax deduction. Can be an excellent tool when a donor wants to give an illiquid asset (such as real estate) and the charity needs time to liquidate the asset in order to pay the annuity income. DGA Sample Calculation 72 year old, sole donor, sole beneficiary Immediate 5.4% = annuity of $540 with an income tax deduction of $4.2k 1 Year Deferral = 5.6% annuity, $560 in income, an income tax deduction of $4.5k 3 Year Deferral = 6.3% annuity, $630 in income, an income tax deduction of $5k 5 Year Deferral = 7.2% annuity, $720 in income, an income tax deduction of $5.4k Planned Giving Group of New England 7

8 Flexible Gift Annuities (FGA) Defer for a minimum of one year, after which donor can elect for the annuity to begin payments. The longer the donor defers the election of a rate, the higher the rate will be when the donor does make the election. Once the donor makes the rate election, the annuity is fixed, there will be no increase in income. There has to be a default year of election, the annuity cannot go on indefinitely. The price of flexibility is that the deduction is limited to the first possible year of election. Flexible Gift Annuities Elective Age at Annuity Total Elective Age at Annuity Total Start Date Start Date Rate Annuity Start Date Start Date Rate Annuity 9/30/ % $ /30/ % $1, /30/ % $ /30/ % $1, /30/ % $ /30/ % $1, /30/ % $ /30/ % $1, /30/ % $ /30/ % $1, /30/ % $ /30/ % $1, /30/ % $ /30/ % $1, /30/ % $ /30/ % $1, /30/ % $ /30/ % $1, /30/ % $ /30/ % $1, Stepped Gift Annuity Annuity generates income that can go up in steps or down in steps. The steps are fixed and cannot be changed once the annuity begins. Upward steps start below the immediate rate the donor would have qualified for, and then go up in increments. Downward steps are sometimes marketed as a bridge product between retirement (age 65) and age for IRA required minimum distributions (age 70.5). Providing higher income for a short term of years followed by lower income for life as either IRA or Social Security income is tapped. Planned Giving Group of New England 8

9 What makes Charitable Gift Annuities Attractive to Donors? Simple to do and simple to understand What makes Charitable Gift Annuities Attractive to Donors? Simple to do and simple to understand Fixed income, regardless of performance of underlying principal. Planned Giving Group of New England 9

10 Overheard at PGGNE: The greatest threat to wealth is longevity. You can t outlive your charitable gift annuity income. What makes Charitable Gift Annuities Attractive to Donors? Simple to do and simple to understand Fixed income, regardless of performance of underlying principal. Typically, lower minimum gift than other planned gifts. What Makes Charitable Gift Annuities Attractive to Donors? Simple to do and simple to understand Fixed income, regardless of performance of underlying principal. Typically, low(er) minimum than other planned gifts. In some ways, more flexible than charitable remainder unitrusts. Planned Giving Group of New England 10

11 How Are Charitable Gift Annuities More Flexible Than Trusts? The deduction for gifts of art and other collectibles is not limited to basis. You can exchange an item the charity wants to use immediately (not sell) for a stream of income. Most often seen at museums that issue annuities in exchange for art. How Are Charitable Gift Annuities More Flexible Than Trusts? Gifts of real estate do not have to be debt free (no mortgage). If you re thinking of making a gift to charity of your home, but you still want to live in it and receive fixed income, you can pair a retained life estate with a charitable gift annuity. How Are Charitable Gift Annuities More Flexible Than Trusts? While charitable gift annuities are limited to two lives, the donor does not have to be one of those lives. With the immediate charitable gift annuity (CGA) it is easy to make a gift of future life income that qualifies for the donor s annual exclusion. Elderly parents Caregivers in lieu of retirement plan Planned Giving Group of New England 11

12 Give the tree, keep the fruit. Anne Melvin No matter what happens to the tree, we ll deliver the fruit. Your charity In closing, here are two charitable gift annuity poster children, Herb and Dorothy. Just your average multi millionaires next door. Planned Giving Group of New England 12