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Conrad Teitell
Elisa Shevlin Rizzo
  Charitable Gift Annuities: A Primer

In this challenging economic climate, charitable gift annuities make financial and social sense for donors and charities alike. An overview of the oldest form of planned gift.

June 18, 2009
by Conrad Teitell and Elisa Shevlin Rizzo

Read no further if you believe that your donor-client will create a gift annuity solely because of the tax and financial benefits. But if the donor believes in the charity's cause and wishes to either retain an income stream for himself or herself or provide an annuity for another, then a gift annuity might be the way to go.

What Is a Gift Annuity?

It is a contract in which a donor makes an irrevocable transfer of money or property to a charity in return for its promise to pay the donor, another individual or both, fixed and guaranteed payments for life. Upon the annuitant's death, any remaining property (the "residuum") is applied by the charity for the charity's general use unless otherwise specified.

The transferred assets become a part of the charity's general assets and payments are backed by all of its assets — not just the transferred property. This is an important distinction between gift annuities and charitable remainder trusts in which the obligation to make payments is limited to the trust's assets.

From the donor's perspective, a gift annuity provides:

  1. An attractive rate of return,
  2. A simple and easy to understand contract,
  3. For itemizers, an immediate income tax charitable deduction and
  4. For appreciated property gifts, reduced capital gains taxation.

Unlike other planned gifts, gift annuities can be funded with "difficult" assets such as retirement accounts, tangible personal property, S corporation stock and real property. They are not subject to the private foundation self-dealing rules or penalties for unrelated business taxable income. Further, gift annuities can provide favorable taxation of life-income payments, reduce capital gains taxation on changing investments, permit capital gain to be reported ratably over the donor's life expectancy and enable a donor to realize the joy of giving (not possible with a bequest).

Reader Note: Meet the author at AICPA Advanced Estate Planning Conference, July 20-22, in San Diego, CA

From the charity's view, a gift annuity is attractive because, unlike other planned gifts, the charity often gets immediate use of the gifted assets. The recommended procedure, however, is to keep the gift (and its reinvestments) until the annuitant's death. However, the charity may spend a portion of the gifted assets, so long as it meets all reserve requirements imposed by the state(s) in which the charity may be registered. Furthermore, gift annuities are a relatively low-cost gift plan and are easily marketed to a wide pool of potential donors as they attract donors whose gifts are not large enough for charitable remainder unitrusts and annuity trusts.

Creation, State Regulation, Taxation of Payments

Creation. Gift annuities are governed by a written agreement between the donor and the issuing charity. These agreements are typically short and easy to understand.

A gift annuity may be for the life of a single annuitant, for the life of one annuitant followed by a successor annuitant or for the benefit of two annuitants during both of their lifetimes, with payments to the survivor after the death of one of the annuitants. In structuring the contract, how the property is owned should be taken into account. Payments may begin immediately or may be deferred until a future time (more than one year from the gift).

State Regulation. The simplicity of gift annuities is complicated somewhat by regulation in some states. Common state requirements include initial registration, licensing, annual information filings, minimum reserves, disclosure information and other requirements. Any charity "doing business" in a state should comply with the filing or registration requirements of that state.

Annuity payments. Annuity payments must be measured by the lifetime of one or more individuals. An annuity may not be for a term of years. The amount of the annual payment is fixed at the outset and never varies. Payment rates are decided by the charity and most charities follow the recommended rates published by the American Council on Gift Annuities (ACGA). For more information on rates, visit ACGA's Web site.

Annuity payments are includable in the annuitant's gross income for income tax purposes but a portion of each payment is treated as a return of principal and is excludable for the annuitant's life expectancy. The excludable (tax-free) amount is established at the annuity starting date.

Income, Gift and Estate Tax Rules

Income tax charitable deduction. Donors who itemize are entitled to an immediate income tax charitable deduction equal to the difference between the value of the transferred property and the present value of the annuity. That value is based upon the life expectancy(ies) of the annuitant(s), the frequency of payments and timing of payments and the section 7520 rate at the time the gift annuity is entered into (or either of the two prior months, at the donor's election). The higher the applicable section 7520 rate, the lower the value of the annuity and the higher the income tax charitable deduction. For this reason, gift annuities are not as tax-efficient in the current low-interest rate environment. But many annuity donors are not itemizers so this may be academic.

Capital gains tax implications. The transfer of appreciated property in exchange for a gift annuity is deemed to be a bargain sale and the donor may recognize capital gain upon entering into the transaction. Any recognized capital gain is taxable to the donor at the time of transfer. However, the capital gain may be reported ratably over the lifetime of the annuitant(s) if the annuity is non-assignable and the donor is the sole annuitant or is one of the annuitants in a two-life annuity.

Practice Pointer: For annuities for spouses, convert separate property to joint property, tenancy in common or community property before funding, so as to report the gain over two lifetimes.

Gift Tax Considerations

The creation of a gift annuity involves the gift to the charity and, in the case of an annuity created for another individual, a potentially taxable gift to that annuitant. The gift to the charity first qualifies for the gift tax annual exclusion ($13,000 in 2009) and the balance qualifies for the unlimited gift tax charitable deduction. In addition, if the gift annuity is for the benefit of another individual, the donor will have made a gift to the annuitant, which may be offset (in all or in part) by the gift tax annual exclusion or the gift tax marital deduction. Gift tax implications can often be avoided by retaining the right to revoke a survivor's annuity.

Estate tax considerations. An annuity for the donor's life is not includable in his or her gross estate. However, the value of a survivor's annuity is includable.

Conclusion

Charitable gift annuities are a winning strategy for many donors and charities alike. In this challenging economic environment, they make economic and social sense for many clients. Keep in mind that the devil, the deductions and the capital gains tax rules are all in the details. This primer gives just the general rules. So be careful out there!

Copyright © Conrad Teitell 2009

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Conrad Teitell is chair, Cummings & Lockwood's National Charitable Planning Group. He is also professor of law; prolific writer; popular lecturer. In addition, Teitell is the author of the five-volume treatise, Philanthropy and Taxation and the monthly, Taxwise Giving. Elisa Shevlin Rizzo is counsel in the Private Clients Group at Cummings & Lockwood, LLC. She can be reached at 203-351-4432.