ELITE ADVISOR BEST PRACTICES
Charitable Gift Annuities
It’s worth the time and effort to get up to speed on CGAs
By Randy Fox
- A CGA is a split-interest donation in which the donor makes a gift but retains a right to an income stream that will last for the lifetime of the last survivor of the donor.
- Most CGAs are in the form of cash or marketable securities, but there are many variations that offer significant planning potential for the well-informed advisor.
- Wise advisors who learn the nuances of this powerful estate planning tool will better serve their clients as well as help worthy causes obtain the charitable funds they need to sustain operations.
Prior articles have discussed the expansion of advisor capabilities utilizing the tools of planned giving. Bequests and beneficiary designations, two fundamental planning strategies, were the focus of the previous two articles. A working knowledge of these two basic charitable methods will benefit every advisor by giving you the ability to articulate essential elements of philanthropy to your clients. This is only the beginning, though. To become truly conversant in charitable planning, you must have a working knowledge of countless techniques, income tax rules, estate tax implications and the way all these methods interact with various types of assets.
Next in importance and popularity is the Charitable Gift Annuity (CGA). This is the first of the split-interest gifts wherein the donor makes a gift but retains a right, in this case an income stream. Most CGAs are very straightforward; individuals or married couples make a gift to a charity in exchange for an income stream that will last for the lifetime of the last survivor. Most gifts are made in cash or marketable securities and provide immediate income to the donor. However, there are countless variations that present significant planning potential for the well-informed advisor.
First, every state has regulations regarding CGAs issued by in-state nonprofits and often in the state of nonresident donors. The CGA is a contract between the charity and the donor, and that contract, much like a commercial annuity issued by an insurance company, becomes a general obligation of the charity. This means that all the assets of the charity are available to pay the annuity income to the donor. This alone has kept many smaller charities from offering gift annuities to their donors. However, there are now organizations such as the Charitable Giving Resource Center (CGRC) that provide turnkey gift annuity programs for small organizations. Assistance includes calculation, administration, financial stability and money management resources for organizations that are too small to handle all those responsibilities themselves.
There is a nonprofit association of organizations called the American Council on Gift Annuities (ACGA) that provides guidance on gift annuities and gift annuity rates. While charities may establish their own gift annuity rates, those that don’t utilize the ACGA rates will be required by their state to hire an independent actuary to perform the necessary calculations. The ACGA rates are meant to provide a remainder balance of 50 percent of the original gift to the charity at the death of the last survivor. This means that the charities have immediate access to some amount of the donated property that they can use for their charitable purposes.
For the donor, perhaps the greatest benefit of a CGA is the ability to make a gift to a favored organization. This should always be the first part of any conversation you have with a client. Discovering a client’s passion and interests while discussing the impact their generosity has on themselves, the organization and future generations has been proven to strengthen client relationships. The psychological and emotional rewards are often enough for many donors.
There are a number of economic and financial benefits as well. First, there is an income tax charitable deduction for the calculated benefit to charity. The deduction is based on the net present value of the future gift. While the formula is somewhat complex, there is plenty of available software to make the calculations. The deduction is available in the year of the gift and can be carried forward for five additional years if the donor is not able to utilize it currently. Planners will note that charitable income tax planning is a very important component of the donative process. Making a gift of the right size with the right timing (and the appropriate assets) requires critical thinking and analysis that the astute advisor can provide.
In addition to the income tax deduction, there is a possible deferral of capital gains tax. Donors who choose to give appreciated property in exchange for their annuity will not realize the immediate gain on disposition that would normally be due upon sale. The capital gains tax will be stretched out over the lives of the income beneficiaries and paid as they receive income. In fact, one of the attractive benefits of the CGA is the nature of the income. Effectively, there is the possibility of three different tiers of income with each annuity payment:
- Ordinary income, which is the presumed interest rate applied to the gift.
- Capital gains tax based on the appreciation of the property over its cost at the time of the gift.
- Return of capital that is free of tax.
These factors can create a very attractive “after tax” income for some donors.
Further benefits come in the area of estate planning. Assets given to charity are normally out of the estate for estate tax purposes. And though there is a retained income, since it ceases at death it essentially removes the gifted asset from the taxable estate. While most estates won’t face federal estate tax because of the current exemption being so high, it is important to remember that many states impose their own estate tax and impose it on far smaller estates.
Other applications and considerations
While we’ve covered the very basics of CGAs, there are many other things to know from the perspective of income flexibility and asset transfer. Most CGAs provide income that begins immediately upon the completion of the transfer of the asset to charity. However, it is possible to establish an annuity or series of annuities that will be deferred for a period of time. It is also possible to structure annuities that increase the payment amount over time. There are many reasons why donors might consider these options. Planning for retirement is the first thing that comes to mind, but providing income to pay for a grandchild’s college tuition is also a common reason. The possibilities seem endless.
Although we have discussed gifts only of cash and marketable securities because they are the most common assets used, almost any other asset can be utilized. With only 10 percent of American wealth held in liquid assets, freeing up illiquid resources might make the best approach. CGAs can be created with gifts of artwork, real estate, cash-value insurance policies, distributions from qualified plans such as IRAs, closely held stock and almost any other asset you can think of. The rules that govern each of these assets vary, and advisors must become familiar with them in order to provide the most appropriate recommendations to their clients.
A gift annuity true story
A local hospital was reaching out to donors in its normal fashion, through newsletters and phone calls. The hospital’s campaign reached a woman named Sarah, and she placed a call to the hospital’s development office listed on the mailer. Sarah had worked at the hospital for more than 30 years as an aide and then as a nurse. Since retiring more than 15 years before, she had steadily given somewhere between $100 and $500 per year. Now 82, Sarah had retired in a low-income housing community and valiantly monitored her expenses. She was healthy for her age and mentally alert and didn’t want to jeopardize her future. But she loved the hospital both for what it did for her during her life and for the care it provided the community.
Because they knew Sarah well, the hospital staff dispatched someone to talk to her, hoping, perhaps, that Sarah could afford to give just a little more, but at the same time knowing that she lived on a fixed income in what could best be described as humble circumstances. After a long discussion, Sarah mentioned that she had a “lot” of U.S. Savings Bonds that she never looked at. Could she give the hospital some of those? A lot ended up being $2 million worth, most of which wasn’t earning interest anymore.
After much research, a lot of hand-holding and some serious number crunching, the hospital agreed to grant a gift annuity in an amount that would still keep Sarah qualified for her low-income housing. It is likely that some of the bonds will pass to the hospital at Sarah’s death.
While CGAs can be remarkably simple on the surface, they encompass many disciplines and have many variations. Wise advisors will make the effort to understand this powerful planning tool and its many nuances to better serve their clients’ charitable desires as well as their estate and income planning needs.