What is a Charitable Gift Annuity?
Charitable Gift Annuities (“CGA”) offer a practical means of giving back to your alma mater or supporting a charity dear to your heart while guarantying a predictable revenue stream during retirement.
When you fund a CGA, you’re entering into a long-term contract with a charitable institution. You agree to make a large donation to the charity and, in return, it promises to pay you a fixed annuity payment for life.
A CGA is useful if you’re thinking about including a large charitable bequest in your will or estate plan but prefer to show your support while you’re still living.
By promising reliable payments for life, the annuity provides some security to donors who might otherwise be concerned about running low on retirement savings.
And CGA’s are partially tax deductible for the current tax-year. Testamentary contributions can only be deducted from estate taxes, which the vast majority of estates don’t have to pay.
Due to the administrative and liquidity requirements, charitable gift annuities are usually only available from large non-profit organizations like universities.
Participating institutions generally manage CGA’s through an office of planned giving or their fundraising departments.
How do Charitable Gift Annuities Work?
Charitable gift annuities are similar to traditional annuities offered by life insurance companies but with the understanding that the contract is ultimately intended to provide financial support for the charity.
As with an ordinary annuity, you’re making a large payment upfront and receiving a promise of periodic smaller payments until death.
However, a life insurance company calculates annuity payments so that, if you reach your life expectancy, you will have received back the principal investment plus interest.
A CGA, though, is set up so that a substantial chunk of money is left over for the charity.
Most charitable gift annuities are funded with a large cash payment, but the initial donation can also come in the form of securities or valuable personal property.
Appreciated assets are a good source of funding for a CGA because you get a break on the capital gains tax.
Institutions offering charitable annuities set a minimum gift amount, typically between $10,000 – $25,000, and most also have a minimum age before donors can begin receiving payments.
This does not necessarily translate into a minimum donor age, though, as the annuity payments can sometimes be deferred so that, for instance, a 55-year old donor might defer payments until after retirement, allowing for the partial tax deduction during prime earning years.
After the contribution is transferred, the institution segregates the funds into a separate investment account.
The donor receives annuity payments from the account on either a monthly or quarterly basis, whichever the contract states.
Whatever remainder is left over upon the donor’s death is retained by the charity.
Payment rates are fixed, so the amount is not affected by investment performance or inflation.
Charitable gift annuity rates are defined in the CGA contract, usually expressed as a percentage of the gift amount.
So, for example, a 70-year-old donor might receive annual payments equal to 4.0% of the initial gift.
Most organizations use the rates set by the American Council on Gift Annuities, which are designed to allow a meaningful stipend to donors while still reserving considerable principal to benefit the charity upon the donor’s death.
Payment Rate Factors
The precise payment rate of the charitable gift annuity depends on factors like the annuitant-donor’s age when payments begin, life expectancy, and the initial gift value.
The older the donor is when payments start, the higher the payments will be because the institution anticipates making fewer annuity payments to older donors.
Likewise, a donor who defers payments will receive larger payments than a donor who starts receiving payments immediately.
If there are two donors – typically spouses – the payment rate is lower because there is a greater chance that one of the two will outlive life expectancy.
What is the Tax Treatment of Charitable Gift Annuities?
The IRS treats the initial donation as consisting of both a charitable contribution and an investment.
The charitable portion is deductible for the tax-year in which the CGA contract is signed.
To determine the ratio, the IRS uses the donor’s life expectancy to estimate the total payments the donor will receive back from the annuity.
The payment estimate is subtracted from the initial gift, and the result is the amount of the deduction.
If significantly appreciated assets, such as securities, are used to fund a charitable gift annuity, the donor can avoid capital gains tax on the growth except to the extent it is paid back to the donor through the annuity.
Payments received from a charitable gift annuity are taxed along the same lines as a standard annuity is taxed.
The portion of payments representing growth or untaxed capital gains (if the CGA is funded with appreciated assets) is subject to either income or capital gains tax.
The percentage constituting “return on principal” (reimbursement of part of the initial gift) is not taxable income.
Each year, the charity sends the donor a Form 1099-R specifying the taxable portion of the payments.
Pros and Cons of Charitable Gift Annuities
The appeal of CGA’s is that you get to reserve a steady income stream in retirement while also promoting a charity that’s important to you.
If the charitable aspect isn’t a big deal, then you’re better off going with a traditional annuity from a life insurance company.
But if benefiting a nonprofit organization without putting your retirement finances at too much risk is your goal, CGT’s are a good option.
And the tax benefits are also noteworthy. You don’t get as big of a deduction as you would with a straight contribution, but the partial deduction effectively equals the amount of the gift when you account for the annuity payments you get back.
The biggest drawback of a charitable gift annuity is that it’s irrevocable. Once you sign the contract, you can’t get the money back.
So, you need to make sure you still have other adequate assets available if disaster strikes.
The annuity payments are only taxable proportionally to the annuity’s growth because most of what you receive is viewed as return of already-taxed money.
However, you might see a considerable increase in the taxable portion of the payments if you outlive your life expectancy.
How do Charitable Gift Annuities Compare to other Approaches to Giving?
Simply writing a big check to a charity gets you a larger tax deduction, but whatever assets are donated are completely out of the picture for retirement and estate planning.
Charitable gift annuities help reduce the risk of being too generous and depleting your retirement savings, thereby facilitating larger gifts for the charity.
However, a straight donation provides more immediate value to the institution because it has access to the money right away. And, with a CGA, you don’t know exactly how much you are truly giving because you don’t know for sure how long you will live.
Naming a charity as the beneficiary on a life insurance policy allows you to keep control of your assets during life and still make a significant gift.
You don’t get an income tax deduction, but it keeps the amount of the policy’s death benefit out of your taxable estate.
There’s also no annuity payment coming back to you. In fact, you are the one making the regular premium payments unless your policy is paid-up.
If you can budget for the life insurance premiums, or your policy is paid-up, designating a charity as beneficiary may allow for a more sizeable donation in the long run. But you don’t get to see the tangible benefits of your gift.
Of course, if your policy has a cash surrender value, you can consider cashing out and gifting the proceeds if you are not otherwise relying on the cash value or the death benefit.
Charitable Remainder Trusts
Charitable remainder trusts (“CRT”) are probably the financial tool that most closely resemble CGA’s.
With a CRT, you fund an irrevocable inter vivos trust, reserve an income stream from the trust assets, and, upon death or expiration of the trust, the remainder goes to the charity.
A CGA and a CRT both allow for predictable cashflow in retirement followed by a charitable donation in the back-end. And both come with a partial tax deduction in the year of funding and are useful in reducing estate taxes and capital gains on appreciated assets.
Distinguish Between CRT and CGA
The primary distinction is control of assets. The corpus of a trust is managed by a trustee, so, if you fund a CRT you can name basically whoever you want to invest the assets.
Your right to receive payments depends upon funds actually being available in the trust.
If investments perform poorly (or you live longer than anticipated) and the trust is depleted, you (and the charity) are out of luck.
Funds in a CGA are invested by the institution, or whoever it designates to invest on its behalf.
And, more importantly, payments are guaranteed by the institution, backed by its assets, and not contingent on investment performance.
Unless the charity becomes insolvent, you can rely on the payments for the rest of your life.
A final distinction worth noting is that a charitable trust allows for more flexibility in selecting an organization to support than a CGA.
If you fund a CRT, you can name essentially any charity you want as beneficiary, or you can name multiple charities.
You can only fund a charitable gift annuity through an organization that offers them, and not all do.
So, if your objective is to support a small local charity, a CGA might not be an option.
For more information about how you might be able to create a CGA for your favorite charity or alma mater feel free to give us a call and we’ll be more than happy to help you get the process started!
My objective was to support a small local non profit via small dollar donations ($10,000+) toward a CGA.
Apparently, from the above analysis, this approach is not a viable option? I guess I was mislead by the numerous large charities and non-profits that aggressively market small dollar donations ($10,000+) toward a CGA purchase. Their appeal for these small donations is apparently just “seed money” toward a subsequently required large dollar donation. Is this reasoning correct? Thank you, Keith
Hello Keith, to offer some feedback, I think you’re dealing with a sophisticated planning option that needs to be explored with someone who does advanced high net worth tax planning. This is not really my forte as I chose to segue away from tax planning and toward integrating life insurance options into various aspects of estate planning. So, you’re proposing something rather complicated as if it should be easy for someone to jump on. This needs to be explained in a presentation.
Best, Steve Gibbs for I&E
Thank you very much for your timely response to my CGA question. I have talked with an “advanced high net worth tax planner”. He laughed at my suggestion of a $10,000 CGA and suggested an outright cash gift of such a small amount. He welcomed a “call back” with a MINIMUM $100K to $500,000+ pledge. I’m trying to provide an option for people who are required to take an annual RMD from their IRA and just want to make a small dollar donation ($10,000+) while realizing a small return and tax benefit from a CGA, without committing to a large dollar traditional annuity. Thanks for any referral.