All about Charitable Gift Annuities
What if you could donate to a favorite charity, get a tax deduction AND receive guaranteed retirement income? It’s possible with a charitable gift annuity.
How a charitable gift annuity works
Unlike other types of annuities, a CGA is not a contract with an insurance company. Instead you are entering into an agreement with a charitable organization.
You make a donation to a charity. The gift can be anything of value, including cash, stocks, real estate or other personal property. Most charities have a minimum gift to qualify; common amounts are $5,000 or $10,000. Most CGAs also set a minimum age for those wishing to donate, typically between 50 and 65.
In return for the donation, the charity agrees to make regular fixed payments to the donor, or an individual he or she designates. CGAs are not issued for a set period of time; payments are made for the life of a single beneficiary or for joint beneficiaries (typically spouses).
You can receive the income immediately or you can defer it to a later date at your choosing. If you choose to defer, you must wait at least one year before receiving payments. Many charities allow you to choose how often you receive income, such as monthly, biennially, quarterly or annually.
Receiving income from a charitable gift annuity
The amount of income you receive from your gift is expressed as a payout percentage. If you donate $100,000 and you’re payout percentage is 4 percent annually, you will receive $4,000 a year in income until you pass away. If you donate $200,000 and receive a 6 percent payout, your lifetime annual income will be $12,000.
The older you are when you begin receiving income from the CGA, the higher your payments.
Most organizations use payout rates that are recommended by the American Council on Gift Annuities (ACGA), an organization that provides educational and other services to charities regarding these arrangements. The ACGA regularly reviews rates and adjusts them based on changes in its assumptions.
The ACGA determines its payout recommendations based on the goal that the charity will make annuity payments equal to no more than half the original donation. So if you donate $150,000, the recipient organization will ideally pay back to you no more than $75,000.
The ACGA bases its formula on the life expectancy of the annuity’s beneficiary. If you and your spouse create a gift annuity together, the rate is based on your combined statistical life expectancies. The payout percentage for joint recipients will be lower than if the payouts ended after one life.
The ACGA’s rates are also based on the assumption that the charity will invest the entire gift at a projected return and hold it in reserve until the death of the annuitant(s). The organization also factors in administrative costs.
Current ACGA recommended payout rates for immediate CGAs range from 2 percent for recipients age 5-10 up to 9 percent for those age 90 and above. The rate is based on the person receiving the income, not necessarily the person making the donation unless they are the same person.
Deferred CGAs use an additional formula to calculate the payout percentages. Under the ACGA guidelines, the annuity will “earn” a 3.25 percent annual compounded interest rate during the deferral period. Therefore, the current payout rate for a certain age will be multiplied by a compound interest factor to determine a deferred payout rate.
Tax implications of a charitable gift annuity
The initial donation entitles the donor to an immediate tax deduction, just as any charitable gift would. The amount of the deduction is based on an estimate of how much the charity will receive after making the annuity payments. In more technical terms, the deduction is equal to the excess of the net fair market value of the donation over the annuity’s present value. This is referred to as the present value of remainder interest.
In addition, you can also save on capital gains taxes if you donate an appreciated security. To receive this benefit, you must directly transfer the asset to the charity: Do not sell it and give the proceeds, otherwise you will have to pay capital gains if the asset has increased in value.
A portion of the annuity payments, the portion considered a return of the principal you gave to the charity, will not be taxable. The remainder of the payments will be taxed as ordinary income.
If the charity repays the entire donation you made, the entire amount of payments made after that will be treated as ordinary income. This typically occurs after you have reached the age of your life expectancy when you entered into the agreement because your life expectancy influenced how much your lifetime payments would be.