Retirement Planning with Charitable Gift Annuities, Part I
Published November 1, 2024
Introduction
For many individuals, at various stages of their careers, retirement planning is an important topic of interest. For those who are charitably minded, charitable gift annuities (CGAs) can serve as a valuable tool for planning and enhancing retirement security. With CGAs, donors can make significant charitable contributions that provide them with tax advantages while securing a fixed income stream. Since CGAs can be tailored to different financial and charitable goals, CGAs can serve as a versatile option for retirement planning.
This article will discuss the fundamentals of CGAs, including what they are, their general registration requirements, their benefits and the two primary variations of CGAs: immediate and deferred. In the second part of this series, we will delve into strategic CGA options for those approaching retirement, including a discussion on flexible deferred CGAs, term-of-years CGAs and CGAs for those who are eligible to use a qualified charitable distribution (QCD). By exploring the different ways that CGAs can be structured, professional advisors can maximize donors’ retirement benefits and support their charitable causes.
Fundamentals of Immediate CGAs
An immediate CGA is a contract between a nonprofit and a donor. The donor transfers cash or appreciated property to the nonprofit and, in return, the nonprofit promises to pay a stream of income for the duration of one or two lives. Sec. 514(c)(5). All the assets of the nonprofit, including its endowment and real property, stand behind the nonprofit’s promise to pay the gift annuity.
The American Council on Gift Annuities (ACGA) is a nonprofit organization that provides education and training in CGAs. The ACGA also provides suggested CGA rates based on the annuitants’ ages. These rates are periodically adjusted to reflect the market conditions and changes in life expectancy. The ACGA’s rate schedule is the industry standard and used by approximately 97% of nonprofits. The suggested ACGA rates target a 50% residuum of the original contribution to the gift annuity. On average, however, nonprofits often receive more than the 50% target. Most organizations tend to follow ACGA rates to ensure they can meet their annuity obligations effectively.
State Regulation
Since CGAs are regulated by the states, an organization who wishes to issue CGAs must comply with state-specific registration requirements. Most states require nonprofits to have segregated annuity reserve funds, and some states will require a minimum reserve amount to cover the nonprofit’s annuity obligations. Organizations may also be required to register and submit their contracts with the state insurance commissioner for pre-approval prior to issuing CGAs. To remain in compliance, certain states also require nonprofits to submit annual financial reports. For a summary of state registration requirements, visit www.crescendointeractive.com and navigate to the Gift Annuity Administration section to find the state regulatory information.
CGA Taxation
A CGA is treated as a bargain sale. This is because part of the transaction is a gift to the nonprofit and part of the asset is a return of value to the donor, with the charitable deduction based on the gift portion to the nonprofit. The payments to the annuitant can be structured for a monthly, quarterly, semiannual or annual basis, with each payment consisting of partially tax-free payouts. When dealing with an appreciated asset that is used to fund a CGA, the capital gain on the gift portion is bypassed and the capital gain attributed to the annuity portion is recognized over the donor’s lifetime, provided the donor is the annuitant.
Example A
Lindsay, a 72-year-old who is about to retire, has a primary retirement account but wants to make sure she will have enough income once she stops working. She holds stock from a major tech company, which she bought for $250,000 and is now worth $500,000. Knowing that selling the stock would require her to recognize $250,000 in capital gains, she decides to contribute the appreciated stock to her favorite local nonprofit in exchange for a charitable gift annuity. This approach not only provides her with a stream of income for life, but it also helps her manage and defer some of the capital gains tax.
Given her age, Lindsay qualifies for a 6.6% payout rate, which produces an annuity of $33,000. She receives a charitable deduction exceeding $195,000, which results in tax savings of over $43,000. By funding the CGA with appreciated stock, she partially avoids the $250,000 in capital gains, bypassing the portion attributable to the charitable gift. With this approach, Lindsay saves approximately $18,500 in capital gain taxes and defers the recognition of the remaining capital gain over her life expectancy.
Age for Immediate CGAs
CGAs are most attractive for individuals who are aged 75 and above. This is not only because older annuitants receive higher payout rates but because nonprofits also benefit by receiving the remainder of the gift sooner, given the shorter life expectancy of the annuitant. For younger annuitants with longer life expectancies, nonprofits run the risk of exhausting their reserve funds as the nonprofit would need to manage the annuity for a much longer period, increasing administrative costs and burdens.
Nonprofits can reduce these risks by considering deferred charitable gift annuities (DCGAs), which present a great alternative for donors who are nearing retirement age. A DCGA permits a donor to secure future income by deferring the start of the annuity payments until he or she needs the income, often in post-retirement.
Deferred CGAs
Deferred charitable gift annuities follow the same rules and requirements as immediate gift annuities with one major difference. DCGAs must have the first annuity payment occur more than one year after the funding date of the gift.
Deferred CGA Rates
Since there is a deferral period between the funding date and the first annuity payout, the ACGA provides a methodology for calculating payout rates. The methodology takes into account the period of deferral between the funding date and the annuity starting date. During this period, the nonprofit is able to hold and invest the funds transferred and thus has a potential to earn income. As a result, the payout rates for DCGAs will be higher to reflect the growth of the gift during the deferral period.
The timing of a DCGA can be ideal for individuals who may still be working but want to secure a deduction now while deferring income until a later date. This deferral period would also allow nonprofits to broaden their donor base and engage with younger individuals, including those who are under 65 who may typically fall below the target age that nonprofits may have for their gift annuity programs.
Example B
Teresa, a 58-year-old animal advocate, is actively planning for her retirement. She is interested in the idea of funding a CGA which would secure her with a lifetime of income. With hopes to support her passion for animals, she approached her favorite animal rescue hoping to provide a $200,000 cash gift in exchange for a stream of income and a deduction. However, the animal rescue informed her that she was too young to qualify for an immediate CGA, due to their internal gift acceptance policy. Their internal policy has a minimum age for CGAs of 65 years.
While Teresa did not meet the age requirement for the immediate CGA, Teresa was open to alternative options. The nonprofit advised she could consider a DCGA as a solution. Unlike the immediate CGA, the DCGA would allow her to make the gift now, securing a charitable deduction for the current year and defer the income payouts until she reached 65. Teresa was pleased and agreed to fund DCGA with $200,000.
Not only was she able to lock in her charitable deduction of $74,372 for the current year, but she can also carry forward any unused deduction for up to five additional years if she exceeds the 60% deduction limit. By deferring the payments for seven years, she qualifies for a higher payout rate of 7.9%. Once she turns 65, her $200,000 gift would generate an income of $15,800, with an estimated total life payout of over $400,000 – double the amount of her original gift. By choosing a DCGA, Teresa found a win-win solution. The deferral period allowed her to be within the nonprofit’s guidelines while also securing a higher payout rate for payments that are perfectly timed to align with her other retirement plans.
Donors who opt for a DCGA will also benefit from a higher deduction amount in the year of the gift compared to the deduction they would get from an immediate CGA. The increased deduction is due to the nonprofit’s extended timeframe to invest the gift before making the payments. The growth over time leads to a larger present value of the remainder interest which results in a higher charitable deduction for the donor.
However, while a longer deferral period results in a higher payout rate, the exclusion ratio for DCGAs is typically lower than the ratio for immediate annuities. The exclusion ratio refers to the percentage of each payment that represents the return of principal, which is tax-free. The reason for the lower exclusion ratio is that, with higher payouts, there is a larger portion of each payment that is classified as earnings and taxed as ordinary income. On the other hand, the original gift portion, which remains the same, makes up a smaller portion of the payment and is considered the return of principal, which is tax-free.
Deferred CGA Variations
For donors who prefer to have more flexibility on when to start and end their payments, there are other DCGA variations that further enhance a donor’s retirement planning. One variation is the flexible deferred charitable gift annuity (Flexible DCGA), which gives the donor the ability to choose a target date for retirement but allows the donor to start the payouts earlier or later than their specified target date. Another variation is the term-of-years charitable gift annuity, where donors can elect to make payments for a set number of years. These advanced variations to DCGAs offer additional options for donors who desire more control over their stream of income and retirement timeline.
Conclusion
In part two of this article series, we will take a closer look at the Flexible DCGA and the term-of-years CGA for donors approaching retirement. We will also touch on CGA options for those who have already retired, such as using a QCD to fund a CGA. By offering various structures to CGAs, nonprofits can enable donors to enhance and customize their income stream to fit their retirement plans, all while supporting the charitable causes they care about.
As discussed, both immediate and deferred charitable gift annuities offer solutions for individuals looking to secure additional retirement income. In comparison to an immediate CGA, donors who opt for deferred CGAs may benefit from a larger charitable deduction and the flexibility to access funds when needed the most. Because this flexibility appeals to a wider range of donors, more specifically the donors who are near-retirement age, nonprofits can broaden their donor pools allowing them to engage with donors that they may have otherwise overlooked due to age. By understanding the different ways CGAs can be structured, professional advisors and nonprofits will be well-equipped to guide donors through their retirement income options.
