How Charitable Gift Annuities Work

By: L. Edgar Barnhill III, Esq.

Article 1

Fact: Interest rates are scraping bottom.

Fact: An important committee for foundations, meeting in April 1992, is likely to move to make conditions less favorable for donors of charitable gift annuities.

Fact: Your church members can obtain a sizable tax deduction and guaranteed, largely tax-free income while at the same time helping your church.

Conclusion: Charitable gift annuities warrant immediate investigation. Reason: The extra-favorable window of opportunity may not last many more months.

What Is It?

Charitable gift annuities, which are sanctioned by the Internal Revenue Service, are a giving technique more than 170 years old.

How it works: Through a charitable gift annuity, a donor transfers cash, stocks, bonds, or real property (real estate) to the church in return for a promise to pay the donor a fixed income for life. These income payments can be made monthly, quarterly, semiannually, or annually. Note: The amount of the payments depends upon:

The age of the donor. The older the donor, the higher the rate of return enjoyed by the donor.

The amount given.

Benefits to Donor

Charitable gift annuities help donors in three ways:

The donor receives an income payment that usually is greater than what is available from other investment sources, such as certificates of deposit or bonds.

A portion of each payment is a tax-free return of principal.

The donor receives a sizable income-tax deduction. Note: This deduction can be used the year it is given or spread out over the next five years.

Example: Mrs. Jones, age 82, gives $50,000 to your church. Your church enters into a one-page agreement with Mrs. Jones wherein you promise to pay her $1,275 (10.2%) every quarter for the rest of her life. Advantage: Of the $5,100 Mrs. Jones receives each year, only $2,273 is reportable as taxable income. Implication: $2,827 is tax-exempt income for her. Plus: Mrs. Jones gets an income-tax deduction of $26,532 (figured from a standardized table) that she can use immediately. Bonus: She has the satisfaction of providing a significant gift to her church during her lifetime, while increasing her current income.

The Church’s Role

Mrs. Jones’s church has received $50,000 and has guaranteed a 10.2 percent return to its donor for life. Challenge: Who can safely generate this high of a return year after year? Obviously, in today’s economy (and just about any economy), generating this type of return is next to impossible.

Key: Fortunately, the church doesn’t have to earn such a high rate of return. Why? A portion of each payment to Mrs. Jones can come from the amount she gave to the church.

Explanation: The rate of return paid to a donor is a factor of age (See Table A). These rates are created by the Committee on Gift Annuities (a voluntary group of representatives from about 1,100 charitable foundations) and are followed by approximately 95 percent of all charities that issue charitable gift annuities. How it works: The rates are set so that, on the average, the charity ultimately will retain approximately 50 percent of the initial gift. Example: Mrs. Jones’s church should expect to retain at least $25,000 after her death.

Options: What should the church do with the money during Mrs. Jones’s lifetime?

It can invest the money and apply the earnings toward the payments owed to Mrs. Jones. Important: Since the church likely will have to dig into the principal to pay Mr. Jones, these funds should be segregated from other church funds to make them available. Remember: Upon Mrs. Jones’s death, the remaining funds can be used for any church purpose.

The church can re-insure its obligation through an insurance company. How it works: The church pays the insurance company approximately $27,500 to reinsure. The insurance company then pays the church $5,100 every year, which the church gives to Mrs. Jones. Advantage: From the original $50,000, $22,500 remains after reinsurance costs, which the church can use immediately.

Suggestions: The former option of investing and segregating the funds may be wise if the church can wait several years (or decades) to access the funds. Reinsurance, on the other hand, may be preferable if the church desires access to the funds immediately.

How to Get Started

To create your own charitable gift annuity program, you will need to:

Become familiar with the federal and state statutes. Note: State regulations vary in complexity, but most are reasonably simple. Important: Review the appropriate regulations with an attorney or charitable-gift consultant who has experience in:

* The state and local taxation of organizations exempt from federal taxation (such as a church).
* The legal requirements of charitable gift annuities.

Obtain the appropriate authorization from your state to issue charitable gift annuities, if that is necessary in your state.

Prepare an information campaign that may include:

* Mailings directed to your retired members.
* Inserts in the church bulletin.
* Introductory seminars.

Implement the program, and plan for the wise use of the proceeds.

Everyone Wins

Charitable gift annuity programs are truly a win-win situation. And with interest rates at twenty-year lows, now may be the perfect time to raise people’s interest in charitable gift annuities.