Conventional wisdom holds that it is better to give than to receive. While this may be true, some givers may find it best to plan for an option that is a little bit of both.
Charitable giving is ultimately a matter of helping a cause about which you care deeply. But your needs or circumstances may restrict the ways in which you can comfortably give. In these cases, a more creative strategy, such as a charitable gift annuity or a remainder interest, may allow you to realize charitable intentions that would be burdensome otherwise.
Charitable Gift Annuities
A charitable gift annuity (CGA) is an agreement between you the donor and the charity or tax-exempt institution you choose to receive your gift. A CGA is a transaction composed of two elements – an outright charitable gift and the purchase of a fixed annuity contract from the beneficiary. That is, in exchange for your gift, the charity agrees to pay a fixed annuity over the course of your life.
CGAs are quite flexible, and allow you (and the charity) quite a bit of leeway in deciding how to set them up. You can control what sort of assets you donate, who the annuitant or co-annuitants are, and when and how frequently payments are made. And while CGAs are only offered over the annuitant’s (or joint annuitants’) lifetime, it is possible to terminate annuity payments early if you no longer need the annuity income. All of these choices impact the way the annuity will work, but all of them are equally viable depending on your personal goals and circumstances.
The amount of this annuity is calculated so that, at the time of your death, the charity can expect to realize a net gain from your original contribution. The rates used for the calculation are often based on those calculated by the American Council on Gift Annuities (ACGA), an Indianapolis-based nonprofit organization. Though charities aren’t required to use the ACGA’s rates, many do to ensure the likelihood that the annuity will not exhaust the complete value of a gift before the annuitant’s death. Using the published rates also saves costs and limits rate competition between institutions. The receiving institution must acknowledge your contribution with a written statement, which will include the difference between a good-faith estimate of the contribution’s ultimate value and the annuity (which is fixed, so once the transaction is complete, its value won’t change).
The CGA rate currently quoted by the ACGA at age 60 is 4.4 percent. The rate decreases for younger contributors and increases for older contributors. The rate caps at 9.0 percent for contributors age 90 and older.
Historically, annuity rates for CGAs cannot compete with those for commercial annuities because of the charitable component of the contract. Payments are structured so that about 50 percent of the donation will ultimately go to the charity, whereas commercial annuities are structured so the majority of the investment will be returned. That said, the tax deductions available for CGAs and the fact that a portion of the annuity from the CGA is a return of principal make the difference in rates less significant. In a low interest rate environment, the spread between the commercial rate and the CGA rate will also be less.
Tax reporting for a CGA is simpler and less expensive than for a charitable trust. Each payment will include a portion taxed as ordinary income, a portion taxed as capital gain (if you donated appreciated property), and a tax-free portion treated as return of principal. The institution will issue you Form 1099-R annually, detailing the information you or your accountant will need for your individual return. After the investment is fully recovered, the full annuity payment becomes ordinary taxable income.
Not every non-profit organization offers CGAs, but many do. The major issuers tend to be religious groups and private colleges or universities. These are popular because donors are unlikely to change their minds about such institutions, making an irrevocable gift like a CGA attractive. Most charities that offer CGAs will have some thresholds determining what gifts they will accept. These rules will usually include a minimum gift size and what types of property they will or will not accept. Closely-held stock, for example, is often prohibited because it is inherently illiquid, making it little help in meeting annuity obligations.
There are many advantages that can make a CGA an attractive option for charitable giving. The first is the immediate charitable income tax deduction. This deduction is generally larger if you defer receiving payments. In addition, the annuity payments themselves receive favorable tax treatment, as described above, and if you donate appreciated assets, you can also control and minimize your capital gains tax burden. If you or your spouse is the annuitant, you won’t generally trigger any gift or estate tax with the transfer (but you will generally need to file a gift tax return, though no tax is due).
In addition, charitable gift annuities are usually cheaper and less complicated to set up and administer than a charitable remainder trust or similar vehicles; they are also subject to fewer, less complicated federal income tax rules. You can also generally give a smaller amount than is necessary to make a CRT worthwhile, some of which you’ll receive back as an annuity. A CGA also minimizes investment risk and management expenses, and gives a guaranteed rate of return.
Furthermore, a CGA gives you the assurance of knowing that, should anything unexpected happen to cut your life expectancy short, the windfall will go to an organization you think worthy, rather than to a commercial insurance company. If you wish to provide some benefit to another heir with your gift, you can also name him or her the annuitant or, alternately, you can use the income the CGA generates to purchase a life insurance policy, naming your heir as the beneficiary. (Note, however, that these choices may have gift or estate tax implications.)
Before deciding on a CGA, it is also important to consider the transaction’s potential drawbacks. One major factor is that a gift connected to a CGA is irrevocable. That means you can’t change the charitable institution you’ve named as the beneficiary later, should your feelings change for any reason. It also means that if the institution is small or otherwise financially unsound, you take the risk that the charity will not be able to meet its annuity obligations. If the charity defaults, you will be one of its many creditors, and there is no way to retrieve your original gift. Careful research is necessary to mitigate this risk, especially since charities, unlike commercial insurers, are not rated by commercial ratings agencies.
There are other potential downsides as well. Unlike a charitable trust, a CGA can only benefit a single charity. Some states also legally restrict or outright prohibit CGAs, so you should carefully research the rules of the state in which you reside and the state in which your charity of choice is based (if different). Finally, it’s important to remember that naming an annuitant who is not you or your spouse may trigger either estate or gift tax rules, depending on whether you reserve the right to revoke the annuity interest. If the annuitant is a skip person, you may also trigger generation-skipping transfer tax rules. Before committing to a charitable gift annuity, it makes sense to discuss your plans with your financial adviser or another knowledgeable professional.
In the context of planned giving, a gift of remainder interest is connected to a gift of real estate. In this sort of gift, you donate your property to the charity of your choice, but retain a life interest in the property. What the institution eventually receives is called the remainder interest, because it is what remains when the life interests ends. The technique is sometimes called a “Life Estate Agreement.”
During the life estate period, you are still responsible for paying property taxes, keeping the premises insured, and maintaining the property’s buildings and grounds. In turn, you retain full rights to use, inhabit or generally enjoy the donated property, as well as any income the property generates. The charity has no right to the property, other than ensuring its remainder interest is protected, for the duration of the life interest.
What makes this sort of gift more attractive than simply bequeathing the property to the organization in your will? For one, a gift of remainder interest bypasses probate, saving the charity time and expense. The organization already holds the deed to the property; the deed simply included a stipulation regarding the life estate. In addition, the property is shielded from any claims creditors may make against your estate. You may also accelerate the end of your life interest, if you no longer have the need or wish to retain access to the property, giving you some measure of control as to when the gift is completed.
You can realize an additional tax benefit if your gift is a personal residence, including a second home, or a farm. Donating certain properties with conservation or historical value according to Internal Revenue Service rules may also allow you to claim an income tax deduction. The deduction will be equal to the remainder interest, rather than the entire value of the property. Unless you extend the life interest to someone beyond yourself and your spouse, the gift will not incur gift tax, though as with a CGA, you will generally need to file a gift tax return even if you are not paying any tax.
Older donors who have debt-free property might also consider combining a gift of remainder interest with a CGA. It would work like this: The donor calculates the present value of the remainder interest in the residence in question. Then, instead of giving the remainder interest outright or using the whole property as a gift to anchor a CGA, the donor would contribute just the remainder interest, while retaining a life interest in the property. The remainder interest would be the gift against which the annuity is set up. This would create a smaller annuity than an outright gift of the whole property, but it would allow the donor to realize an income tax deduction and receive a steady stream of income while retaining the rights to live in or use the property.
Whether you use either technique or a combination of the two, CGAs and remainder interest gifts allow you to benefit from your gift during your lifetime, while also ensuring a substantial gift to the organization of your choice. They are both ways in which your planned giving can let you have your charitable cake and eat it too.