Introduction

Many clients seek guidance from professional advisors regarding retirement, investments, tax planning and charitable giving. These clients are often concerned with maintaining their standard of living and looking for a way to support their favorite charitable organizations. Life income gifts are a great solution for clients who desire a steady source of income for the duration of their lives, while also providing a legacy for charity.

Due to substantial tax changes, now is a great time to suggest charitable solutions for clients. Part one of this article will discuss charitable gift annuities and part two will focus on charitable remainder trusts. This two-part article series will provide illustrations for the gift models and practical pointers to help guide a client toward the gift model that will best fulfill his or her philanthropic goals.

Charitable Gift Annuities

A charitable gift annuity (CGA) is a contract between a donor and a charitable organization. The donor contributes a gift of cash or appreciated property in exchange for the charity's promise to pay a fixed annual amount for the life or lives of the specified annuitants. The CGA is secured by all of the assets of the charity. CGA contracts are irrevocable and non-assignable, except to the issuing charity.

CGAs appeal to a broad range of clients, ranging from individuals with high net worth to those with modest means. A CGA donor will receive several tax benefits, including a charitable income tax deduction and partially tax-free payments. If appreciated assets are used to fund the CGA, there will be a partial bypass of gain. The annuitant may not be subject to capital gain taxes at the time of the gift. The capital gain on the gift portion of the CGA will be bypassed. The capital gain on the annuity portion will be recognized over the life expectancy of the annuitant.

When an individual funds a CGA, part of the contributed property is considered a charitable gift and part is return of principal to the annuitant in the form of payments. In order for the CGA to qualify for a charitable deduction, there must be a minimum 10% charitable deduction at the creation of the gift annuity. The charity cannot guarantee a minimum or maximum number of payments. The payments are secured for the life of the annuitant.

CGAs provide fixed payments for the life or lives of one or two annuitants. The payout percentage will be based on the annuitants' age and is fixed for the duration of the contract without adjustments for cost of living or inflation.

Most charities choose to follow the American Council on Gift Annuities (ACGA) suggested gift annuity payout rates. The recommended rates are based on a 50-50 blend of gender with a mortality assumption under the 2012 Individual Annuity Reserving Table. The ACGA assumes a mixed portfolio for the annuity investments of 40% equities, 55% fixed and 5% cash investments. The ACGA rates assume a gross investment return of 4.25% per year on the gift annuity fund with expenses of 1% per year. Based on those assumptions, the ACGA rates are calculated to leave roughly 50% of the original funding value to the charity.

An immediate CGA will be structured to start paying out during the first year of the gift. Immediate annuities will start making payments within one payment period of the funding of the annuity. The annuity payout rate is based on the age of the annuitant at the time of the gift. If a client is interested in setting up a CGA with a specific charity, the advisor should find out if that charity has any age limitations for its CGAs.

Example 1: Immediate CGA

Doug and Jane meet with Angela, a gift planner from State School. Doug and Jane are seeking to supplement their retirement income. Angela encourages them to consider funding a CGA with State School as part of their retirement plan. They wish to make a gift of highly appreciated publicly traded stock in the amount of $250,000, which has a cost basis of $15,000. Doug is 77 and Jane is 75. Based on the ACGA suggested rates, they would be entitled to a 5.1% annuity payout. Their gift would allow them to claim a charitable income tax deduction of $106,290. Doug and Jane love the idea of supplementing their income in their retirement years. They like the charitable income tax deduction and the legacy gift to charity. They are also pleased with the annual fixed annuity payments of $12,750.

Deferred Charitable Gift Annuity

A CGA may be structured as a deferred annuity, which starts making payments more than one year from the date of the gift. The annuity starting date, for purposes of determining the payout percentage, is one payment period prior to the first payment. Individuals who choose a deferred payout CGA often have a higher payout rate than if they had chosen an immediate CGA. The ACGA suggested rates for deferred annuities take into account an assumed growth rate for each year the CGA is deferred. This assumed growth rate for the deferral period increases the fixed annuity payout rate. The annuity payout is based on the annuitants' age at the time of the starting date.

The deferred CGA option can be particularly helpful for clients planning for retirement. Individuals may want to defer payouts for five, 10 or even 20 years. Charities may have an age threshold for accepting CGAs and deferred payment CGAs. Clients who have not yet reached the charity's minimum age for setting up an immediate annuity may be able to set up a deferred annuity to begin payouts once the client reaches a certain age.

Example 2: Deferred CGA

Brandon and Amy meet with their favorite foundation to find out how they could support its mission. They hope to supplement their income later in life. Brandon and Amy also desire a charitable tax deduction while they are still in their income earning years. They wish to use cash to fund the annuity and are willing to gift $300,000. Karen, the gift officer, suggests that Brandon and Amy consider a deferred payment CGA, as they are 55 and 50, respectively. Karen explains that if they are willing to defer payouts from the CGA for 15 years, they can set up an annuity with a 6.9 % payout rate. This will provide payments of $20,700 annually. They will also be entitled to claim a charitable income tax deduction this year of $99,593. This gift annuity proposal meets Brandon and Amy's goals. They are more than willing to wait until retirement to begin receiving payments from the annuity. Brandon and Amy are overjoyed with the large charitable income tax deduction in the year of the gift.

Flexible Deferred Charitable Gift Annuity

A client might also consider setting up a flexible deferred annuity. In Private Letter Ruling (PLR) 9743054, the Service approved the use of a flexible deferred annuity. While a PLR is not precedent, it can be helpful to determine the Service's position on an issue. With a flexible deferred annuity, a donor selects an expected start date, or target date, for the annuity payments. The donor will also select a range of dates specifying the earliest and latest date the annuitant can elect to being receiving payments. The target date is used to determine the charitable tax deduction. However, the donor may elect to start receiving payouts at any time between the earliest and latest payout dates selected.

If a flexible deferred annuity is chosen, the payouts will be based on the start date. If the donor elects to begin receiving payments before the target date, the annuity payout percentage will be lower. If the donor elects to begin receiving payouts after the target date, the payout rate will be higher. The CGA contract will require donors to elect to begin payouts in writing one payment period prior to the desired annuity start date. This can be a great option for clients who do not know when they would like their payments to commence and would enjoy the ability to choose to start payments rather than have a certain date.

Taxation of Charitable Gift Annuities

CGA payments may be especially attractive due to the taxation of the income payments. A portion of each CGA payment will be tax free because it is a return of the donor's principal. The tax-free portion of the income payment will continue until the annuitant reaches life expectancy as calculated as of the gift date. Once the annuitant reaches life expectancy under the Service's Section 72 life expectancy table, all future payouts will be ordinary income.

If a CGA is funded with a capital asset and the donor is also the annuitant, a portion of the capital gains may be prorated over the donor's life expectancy. Gifts of stock, real estate and other appreciated assets will provide a partial bypass of capital gains and charitable income tax deduction for the donor. The income payments are tax favored as they will be partially tax free and capital gain income rather than all ordinary income.

If the donor is not the annuitant, the portion of the capital gain attributed to the annuity will be recognized by the donor in the year of the gift. Advisors should be cautious in recommending the use of capital assets to fund gift annuities if the client is considering funding an annuity that will make payments to another person.

Charitable Gift Annuity Contracts

Most charities have a set of standard CGA contracts drafted by legal counsel. This standard contract is easily modified for each annuity issued by the organization. Several states require issuers of CGA contracts to have their form contracts pre-approved with the state. If a standard annuity contract is used, CGAs can be cost effective for the client as well as the charity, because no additional drafting is required.

State Requirements for Charitable Gift Annuities

A charitable organization's ability to issue a charitable gift annuity will depend on state law. Different states have different approaches when it comes to CGA regulation. There are generally four state approaches to CGA regulation, which are: registration states, notification states, conditional exemption states and silent states.

Registration states require the charity to obtain a permit or license before the charity is able to issue CGAs in that state. Registration can be an expensive and time-consuming project for charities. These states also require annual reporting.

Notification states, on the other hand, do not require a full registration. Rather, states using a notification approach generally require charities to meet certain specifications and provide notice to the state prior to issuing gift annuities in the state. The charity must simply send a letter or state-issued form to the state. In the letter, the organization notifies the state that it meets the state's requirements for issuers of CGA contracts and that it will be issuing gift annuities in that state.

Conditional exemption states require that charities meet certain specifications, but no registration or notification is required prior to issuing CGAs. Finally, some states are silent with regard to gift annuity regulation. These states do not have any case law or statutes related to gift annuities. Depending on state regulations, charities issuing CGAs may be required to hold a portion of the value of the annuity in a reserve account to secure future annuity payments.

Conclusion

Life income gifts help clients meet their philanthropic goals and financial security needs. Charitable gift annuities are a great option to provide support for a charity, while also receiving fixed payments for the life or lives of the annuitants.

CGAs are a great supplement for clients in, or nearing, retirement. Advisors often find that their clients enjoy the benefits of the charitable deduction and fixed, partially tax-free payments so much that they end up creating multiple CGAs over their lifetimes. Not only are CGAs easy for a client to understand, they are easy and inexpensive to set-up when compared to other planned gift models a client may consider. CGAs can create substantial legacy gifts for charity and thus, can fulfill a donor's charitable goals as well. By understanding how various gift models operate, advisors can help guide clients to the life income gift that best suits their clients' needs. Charitable gifts are a wonderful solution to provide financial security, income tax savings and meet the client's philanthropic goals.