Charitable Gift Annuity for Income and Estate Tax Savings


	Kelly White

September 2008

Double-Dipping for Income and Estate Tax Savings

A charitable gift annuity reduces your estate, produces an income tax deduction, and enhances income during retirement years

When updating their wills or trusts, many people designate a specific bequest to a favorite charity. For example, the will might direct $50,000 or $100,000 to a church or a hospital, and the rest of the estate is split equally among the children. Charitable bequests such as these reduce the taxable estate of the donor, and that portion of the net worth is free of any estate tax. However, because it is a post-death transfer, it offers no income tax savings.

For many, there is a better alternative. If your commitment to a charitable entity is rock solid, consider initiating the transfer during your lifetime with a charitable gift annuity. This strategy produces an income tax deduction and enhances income during retirement years.

A charitable gift annuity is a contractual arrangement between a donor and a charity. The donor transfers cash or other assets to the charity and receives from the charity a fixed annuity that is payable for lifetime. Married donors will generally structure the annuity to pay as long as either spouse is living. Charitable gift annuities are generally considered to bring three advantages:

greater income during retirement,
a charitable income tax deduction at inception, and
a retirement annuity that is partially tax free.

The major disadvantage, of course, is that there is no residual inheritance for the children. But that is the same outcome that would have occurred with the post-death charitable bequest through the will or trust.

Enhanced income. Most charities that offer gift annuities use the rates established by the American Council on Gift Annuities. The rates are based on the age of the annuitant at the inception of the contract, with the rates based on whether the annuity is payable over one life or two. Here are some sample payout rates for a one-life annuity:

Age

Payout

5.8%

6.1%

6.9%

8.0%

Annuities that pay out for two lives will have a lower percentage, based on the greater longevity of two recipients. Here are several illustrations of the current two-life rates:

Age

70-70

75-75

80-75

80-80

Payout

5.6%

6.0%

6.2%

6.6%

For many retirees, the current low interest rates on investments, as well as the fluctuations in the stock market, have produced diminished income. These gift annuity rates present an opportunity to lock in a solid cash flow that won’t fluctuate.

Charitable income tax deduction. Because an individual who commits to a charitable gift annuity has made a permanent transfer for the benefit of a charity, a charitable deduction is allowable at the inception of the agreement. The charitable deduction will vary with the age and income payback to the individual but generally is about 30%-45% of the value of the property transferred in exchange for the annuity. This large income tax deduction can be a significant advantage to the donor and represents a deduction not available if residual wealth is simply bequeathed to a charity after death.

Partially tax-free income. Another advantage of a charitable gift annuity is that the income stream is, in most cases, only partially taxable. Part of each annuity payment is considered return of the donor’s tax basis in the property. The portion that is tax-free depends on the individual’s age and duration of the payments, the payback rate and the IRS interest rate at inception.

Example. Art, age 72, owns stock in several publicly traded companies. The value of the stock is $100,000, and Art is concerned about the fluctuations in value and possible decline in his stock’s market price. The stock has a tax basis of only $30,000 and, if Art sold it, would trigger a significant gain. Instead, Art transfers the $100,000 worth of stock to a charity in exchange for a gift annuity that pays Art 6.3% for lifetime ($6,300 annually, or $1,575 per quarter). Upon entering into this transaction, Art has no capital gain from disposition of the securities; rather, he receives a charitable deduction of about $42,000.

Because Art’s transfer was appreciated capital stock, this $42,000 charitable deduction is limited to 30% of Art’s adjusted gross income in his Form 1040 each year. If Art’s annual 1040 income is $60,000, he claims an $18,000 charitable deduction ($30% x $60,000). Any excess charitable deduction carries forward to future years, subject to a five-year limit. Under these rules, it would take Art three tax years to fully consume the $42,000 deduction.

Art’s annual annuity of $6,300 is only partially taxable. Approximately $1,200 is tax-free each year, about $2,800 represents capital gain, and about $2,300 is ordinary income. By entering into this gift annuity arrangement, Art has improved his annual cash flow, converted his stocks into an asset that produces a steady income stream, and created a large charitable income tax deduction to benefit his Form 1040. Furthermore, the stock will not be subject to estate tax upon Art’s death, as it is now out of the estate.

Charitable gift annuities are attractive to those who want a stable income that they cannot outlive. If the donor is already committed to making a post-death gift to charity, the gift annuity simply accelerates the commitment. But it also brings the added benefits of an income tax charitable deduction and an enhanced retirement cash flow.

Charitable gift annuities may be appropriate for even smaller charitable transfers, as they are transacted with little or no overhead. The charity simply must have an established charitable gift annuity program. For those considering larger transactions, a “charitable remainder trust” provides essentially the same benefits, with the added advantage of flexible design to fit the donor’s objections and tax situation.

For assistance with charitable gift annuities or charitable remainder trusts, please contact your Schmidt Westergard & Company tax professional.

Based in Mesa, Arizona, and serving closely held businesses in the East Valley, the Phoenix area and throughout Arizona, Schmidt Westergard & Company, PLLC, is an independent full-service tax, audit, accounting and business advisory firm focusing on the middle market.