7 Little-Known Gift Annuity Applications

April 15, 2009 by  
Filed under Featured

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Gift annuities are popular planned giving tools. They have been around for over 100 years. They are easy to understand, simple to set up and don’t have the higher administrative costs associated with other charitable giving techniques.

Most people think the income from a gift annuity is for the life of the donor or for the joint lives of the donor and spouse. There are, however, at least seven other ways a gift annuity can be used. Let’s take a look at the two traditional applications and then summarize the other seven options. Perhaps these will plant a seed for their use in your situation that will also benefit your church.

Your Life Only

This is the most common and straightforward way a gift annuity is structured. You contribute cash or an appreciated asset to your church in exchange for a life income. At your death, the church keeps your contribution for its use.

For as Long as You and Your Spouse Live

You can also set a gift annuity up to pay out for as long as either you or your spouse lives. This is the joint and survivor gift annuity option.

Here are the 7 techniques you may not be familiar with…

1.  For as Long as You and Another Person Live

The other annuitant does not have to be your spouse. For example, a woman could establish a gift annuity for her and her sister.

2.  For the Life of Someone Other Than You

Furthermore, the gift annuity does not have to be for you. You could have a disabled child who requires special care and set up a gift annuity to fund that care for the rest of their life.

3.  The Payments are Deferred for a Number of Years

Most gift annuities are paid out monthly, quarterly, semi-annually or yearly. Normally, the payments begin within the first year. However, it is possible to defer the start of the payments for a number of years.

For example, a person who is age 55 could set up a gift annuity with the idea that the payments would begin at age 65 to supplement their retirement income. Deferred gift annuities have the advantages of a higher payout and an increased charitable deduction.

4.  To Fund Education for a Child or Grandchild

Another example of a deferred gift annuity is funding the education for a child or grandchild. You set up a gift annuity now for your five year old grandson and when he is 18 and off to college, the gift annuity can be triggered to pay out over the next four or five years. There is some risk as the boy is not obligated to use the funds for college. You could be funding his Corvette Z06.

5.  The “Re-insured” Gift Annuity

In my opinion, this technique should be employed more often because it provides cash for the church immediately.

Instead of holding the contribution to a gift annuity, then investing and paying out the promised payment, the church buys a commercial immediate annuity from an insurance company. The insurance company is instructed to send the (i.e. quarterly) payments to the church and a check is cut to the donor.

The cost of the immediate annuity will vary and is dependent on several factors such as the age of the donor and the prevailing interest rate in the economy. Nevertheless, the cost of the immediate annuity is less than the amount received from the donor. This difference is available to the church immediately.

6.  Exchanging a Charitable Remainder Unitrust for a Gift Annuity

If you are the income beneficiary of a charitable remainder unitrust (CRUT), you can exchange this interest for a gift annuity. This move can satisfy many objectives.

This gives you another charitable income tax deduction for the new gift annuity. The advantage to the charity is that is frees up money immediately that may be needed for a building campaign.

7.  Creating a Gift Annuity at Death With an IRA

All, or a portion of, your IRA can be exchanged for a gift annuity at your death. This would be a way to establish  a safe, consistent income for your surviving spouse for as long as he/she lives with the funds ultimately going to the church you both desire it would go to anyway.

Your estate would get a charitable deduction for the charitable portion of the gift annuity. However, the IRA proceeds would still be income in respect of a decedent and subject to ordinary income taxes just as if you had left the IRA directly to your spouse.

Summary

These explanations of the various uses for a gift annuity only represent the tip of the iceberg. If one or more apply in your situation, you’ll need to consult a qualified tax professional. Each technique has positive and negative income and gift tax results.

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  • Brooke Fraser

Comments

3 Responses to “7 Little-Known Gift Annuity Applications”
  1. Tom Cullinan says:

    Your option #5 is a path not to take. Best practices require the church/charity to reserve 100% of the gift amount, so if a portion (say 60%) is used to purchase reinsurance, the remaining 40% is reserved and invested with the rest of the gift annuity pool for the life of the contract. Should the reinsurer default, a rare yet possible event, the church/charity is obligated to make the payments for the life of the contract.

    Also, be aware that if reinsurance is required by church/charity policy (for example because the contract is too large, or one family is responsible for a disproportionate share of the gift annuity program, or is quite young) then that changes the charitable deduction calculation as well as the composition of the annuity payments over the annuitant’s life expectancy.

  2. For the benefit of the church leaders reading these posts, Tom Cullinan is a nationally-recognized authority on planned giving. I’m just privileged to have him even read my blog in the first place.

    I am however, going to respectively disagree and advance some additional information to support my line of thinking.

    There are differences of opinion, to be sure, about re-insuring using a commercial annuity. In my experience, it boils down to whether or not the church wants immediate access to some of the donation. The suggestion of investing the difference between the donation and the cost of reinsuring is certainly an option if a need for current funds does not exist. However, to invest as an added assurance against the insurance company defaulting is, in my view, overly conservative. I have been in the life insurance business for 40 years and know of no case where a policyholder has been stiffed by a default.

    To assure that the donor would receive the standard charitable income tax deduction, rather than the modified reinsurance charitable income tax deduction which would be the case if reinsurance is required, it is my understanding the church/charity should have a discretionary option, not mandatory, to reinsure.

    The situations where I have used a commercial annuity to fund a CGA agreement were with small organizations that did not have a formal gift annuity program with an invested gift annuity reserve fund. So we weren’t “reinsuring” anything; we were simply funding the organization’s obligation in a manner that gave the donor greater peace of mind knowing their payments were coming from a financial institution with billions of dollars as opposed to the church or charity that barely has two nickels to rub together.

    For those situations where the charity mandates reinsurance, I’ll toss in two other factors.

    One of the elements in the calculation of the charitable income tax deduction allowed in a gift annuity transaction is the Applicable Federal Rate (AFR), an interest rate set monthly by the IRS. Due to the decline in interest rates, the AFR has been dropping. In February 2000 it was 8.0%. The last few years, it’s been in the 5-6% range. In February, 2009, it hit a record low: 2.0%. For gift annuities, the lower the AFR, the lower the charitable income tax deduction.

    First, declining AFRs lessen the spread between the standard and modified deduction. For example, the American Council on Gift Annuities recommended payout percentage for a 75 year old is 6.3%. Using the March, 2009 AFR of 2.4% results in a deduction of $42,217 on a $100,000 donation. The cost to buy a life only, no refund annuity on a 75 year old female that will pay $6,300 a year is $64,116, so the deduction would be $35,884. Not that big a difference. When the AFR was 5.0%, the standard deduction would have been $51,503.

    Second, I did not bring up the fact that immediate annuities today can be medically underwritten. If the donor has health problems, the cost of the annuity is lower. I had a case where the medically-underwritten annuity was 40% less premium. Applying that savings to my 75 year old woman example would lower the cost of acquiring the annuity to $38,470, thus increasing the deduction to $61,530. This is more than the $42,217 standard deduction.

    Nevertheless, Tom’s points are well taken. In any given situation, the final decision must fall on the church/charity board and their legal counsel.

  3. Hi,
    Oh its a great post.
    This is really interesting one to read. All the seven annuity applications are great to examine. The fourth and the sixth are especially awesome applications. But one thing to be aware of is that if reinsurance is required by church/charity policy family is responsible for a disproportionate share of then that changes the charitable den as well as the composition of the annuity payments over the annuitant’s life expectancy.
    Thanks.

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