A gift annuity is a very popular agreement between a donor and a charity. This article will describe the gift annuity and explain the roles of each party to the agreement. A gift annuity is a contract that involves a transfer of property by a donor and a gift to charity. With this gift, there is a charitable tax deduction.
Gift Annuity Description
A gift annuity agreement is a contract between a donor and a charitable organization. The donor transfers property and the charity agrees to make fixed payments for one life or two lives.
The gift annuity is generally very safe for the donor. The charity maintains a gift annuity reserve fund. In addition, the charity backs its promise to make gift annuity payments by all of its assets – its gift annuity reserve fund, its endowment and any real estate that it owns.
Because the gift agreement will produce a charitable benefit at the end of one life or two lives, there is a charitable income tax deduction. In addition, part of each payment is tax-free.
Gift Annuity Payout Rates
The older the annuitant, the higher the payout rate. This higher payout reflects a shorter life expectancy and explains why gift annuities are most popular with senior donors. Most charitable organizations follow the rates set by the American Council on Gift Annuities.
Charitable Gift Annuity for Susan Green
Consider an example: Susan Green is about to receive $20,000 as a certificate of deposit matures. She decides that she would rather increase her income significantly by giving the $20,000 to her favorite charity for a gift annuity.
She would receive some great benefits with this plan. When Susan creates the annuity, she receives a charitable deduction for $9,151. If she itemizes and takes this charitable deduction, it could save $2,928 in income tax.
Based on Susan’s age, the annuity payment is 6.2%. This payout of $1,240 per year is usually distributed in four equal quarterly amounts. Susan will receive a nice payout from the gift annuity for her life. If she lives to be 90, 95 or even 100, she continues to receive those fixed payments.
A welcome benefit for Susan is that part of the payment is tax free. With a charitable gift annuity, a portion of the principal in the annuity contract is paid back to the annuitant over his or her estimated life expectancy.
When Susan passes away, the charity will receive the residuum, or the balance remaining on the gift annuity. This may be more or less than $20,000, depending on how much has been earned and how much has been distributed. For organizations that follow the rates set by the American Council on Gift Annuities, with fairly conservative earnings assumptions, the target gift annuity residuum is 50% of the initial funding amount.
Gift Annuity Participants
Generally, there are four parties to a gift annuity. There is the donor, the charity, the annuity recipient (who often is also the donor) and the state insurance commissioner.
The donor transfers property to the charity. The charity promises to make fixed payments for one or two lives. While the annuity recipient is usually the donor, a gift annuity could also be funded for a friend or relative.
Finally, gift annuities are subject to regulations in a number of states. The insurance commissioner is generally in charge of carrying out the regulations passed by the state legislature. He or she will act to protect the interests of the gift annuitant. In some states, there are specific reserve and investment requirements for the gift annuity reserve fund.
The tax deduction for a gift annuity is calculated using tables and methods created by the IRS. Using those tables, it is possible to determine the value of the payments for the estimated life of the donor. This value is then subtracted from the total amount transferred to calculate the gift. The gift value is a charitable deduction in the year the annuity is created.
The contract value is then used to determine the amount of tax-free payments. The contract value is essentially transferred back to the donor over his or her estimated life expectancy. This amount is the basis for the tax-free portion.
Payouts – Cash Annuity
Gift annuity payouts are partly tax free, but also partly subject to tax. For a gift annuity funded with cash, a portion of the payment is ordinary income and the balance is tax free.
This rule applies until the annuitant reaches his or her life expectancy. If the annuitant survives past that time, the entire payout is taxed as ordinary income.
Payouts – Stock for Annuity
If a donor transfers appreciated stock for a gift annuity, the payments will be taxed differently than a gift annuity funded with cash. In addition to the tax-free and ordinary income portion, part of each payment would be considered capital gain.
The capital gain is allocated in part to the contract and then prorated over one or two lives. At the end of each year, the charity will send the annuitant IRS Form 1099-R. It will explain to the tax preparer what will need to be reported as ordinary income and how much will be reported as long-term capital gain. Once again, if the annuitant lives past life expectancy, all further payments will be ordinary income.
Two Life Gift Annuity for the Hendersons
A husband and wife might establish a charitable gift annuity with appreciated stock and ask for the payments to be made for both of their lives. The annuity initially would pay equally to husband and wife and then would make the payments to the survivor as for his or her life.
Assume, for example, that a husband and wife initially purchased a block of stock for $40,000, but it has grown in value to over $200,000. They decide to use that stock to fund a charitable gift annuity.
Based on their ages, the ACGA payout percentage is 5.2% annuity. This amount is payable for the two lives. They also receive a charitable income tax deduction of $69,846. The capital gain on that portion is bypassed. However, the capital gain on the contract is then prorated or spread out over the lives of the husband and wife.
The gift annuity funded with stock produces a very nice charitable deduction, fixed income and favorable tax results. Part of the payment will be tax free. A portion of the payment will be long-term capital gain and the balance will be ordinary income.
Benefits For Charity
Gift annuities provide three major benefits for charities. First, the charity receives the gift portion of the agreement when the donor passes away. Second, many donors with existing gift annuities have extra income. A common pattern is for these donors to use that extra income to fund additional gift annuity agreements. Third, the positive feelings of fixed payments for life lead many donors to leave bequests to charity. The cumulative benefits of a gift annuity program are excellent for charitable organizations.