Charitable Gift Annuity Guide
Although annuities are customarily issued by insurance companies, there is nothing to prevent any company or individual from issuing one. An excellent example of this is the charitable gift annuity (CGA), an annuity issued by a charity to a donor in exchange for a gift to the charity.
Like much economic activity, the charitable gift annuity is motivated by the tax laws. Charities usually attract donations without having to issue annuities to donors, while donors usually buy annuities from insurance companies rather than charities. What special circumstances attract both parties to the CGA arrangement? The added element to this transaction is the tax deduction received by the donor on the gift made to the charity.
The Charitable Gift Annuity
Consider, in the abstract, possible reasons that might motivate an individual to bypass the insurance companies when seeking an annuity. Suppose, for example, that the would-be annuitant is dissatisfied with the annuity payouts offered by the various financially-sound insurance companies. (The subset of insurance companies that are financially rock-ribbed is much smaller than the universe of companies, so this is not far-fetched.) He might turn to the charity of his choice and donate a financial asset – shares of stock, a bond, or any other marketable asset. In return, the charity could sign a contract offering him a life-annuity payout at the “going rate” of return (given his life expectancy). He would prefer to deal with the charity because he would also gain a tax deduction on the value of his charitable donation.
The charity can use income from the donated asset to make the annuity payments, which are a liability on its balance sheet. Thus, the annuity payments are backed by the charity’s entire assets, not just income from the donated asset. This makes the donor/annuitant a general creditor. (That contrasts with the similarly-named charitable remainder trust, with which charitable gift annuities are sometimes confused.) The payout usually follows that of a life annuity – level lifetime payments, part of each one representing a return of “principal.”
Regulation of Charitable Gift Annuities
The foregoing example is actually hypothetical. It represents a limiting case in which the gains from the CGA flow through to the consumer. In practice, the structure of charitable gift annuities is skewed to benefit charities rather than donors. Because annuities are, in effect, insurance products, they are regulated at the state level.
Charitable annuity prices and payouts are set so as to preserve value in the donated asset at the expiration of the donor’s life expectancy. If the donor/annuitant’s life exactly tracked its actuarial expectancy, the asset’s remaining value or “residuum” would then pass to the charity. Many state laws governing charitable annuities require the residuum to be at least 50% of the original value of the donated asset. Guidelines formulated by the American Council on Gift Annuities follow this rule of thumb, and federal law exempts charities from some forms of regulatory scrutiny provided their prices and payouts comport with ACGA strictures.
This type of collusive pricing behavior suppresses competition among charities. (Indeed, a lawsuit by an aggrieved purchaser forced Congress to provide charities with an antitrust exemption.) Annuity purchasers looking for the best possible payout should closely compare charitable annuities with insurance-company products before settling on a final choice. Of course, a purchaser whose motivation is primarily charitable might welcome arrangements favorable to the charity. In addition to annuity rates and payouts, state regulation of charitable annuities also focuses on allowable expense ratios and required reserves.
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Types of Charitable Gift Annuity
Just as standard annuities can be divided into immediate and deferred, so also can charitable gift annuities. An immediate charitable gift annuity has payments that begin in the payment period immediately following the date of purchase. Just as with insurance-issued annuities, payments can be made monthly, quarterly, semi-annually, or annually. A common arrangement on a quarterly CGA is to prorate the first payment over the time period between contribution date and the end of the quarter, then schedule payments on the ending date of subsequent quarters.
A deferred CGA puts off the first payment for a period longer than one year. Once again, payments may be made monthly, quarterly, semi-annually, or annually. A third type of charitable gift annuity is a flexible charitable gift annuity, in which the annuitant need not specify a starting date for payments at time of purchase. The donor would receive a fixed charitable deduction and the charity would supply a range of variable annuity payouts for various start times, with later dates providing larger payments.
Each year, the annuitant would choose whether or not to begin payments. It should be noted that this format can accommodate a gift not only to a charity but also to an annuitant – the donor need not be the annuitant.
Payout Recipients for the Charitable Gift Annuity
There may be more than one annuitant party to the CGA contract. Although the “single annuitant” structure is the most common one, the “survivorship” structure allows another annuitant to succeed as annuitant should the original one die. “Joint and survivors” allows two annuitants to share the payments until one dies, at which point the other one inherits full payments for the remainder of his or her life.
A charitable gift annuity adds two additional kinds of benefits to the traditional insurance-company-issued annuity. In addition to the usual annuity payments, a charity receives a donated financial asset while the donor (who may or may not also be the annuitant) receives a tax deduction for the charitable donation.
The charity can use income from the donated asset to make the annuity payments. Any remaining value in the asset will revert to the charity upon the death of the annuitant(s). Both industry practice and government laws are oriented toward protecting the charity’s income rather than fostering competition among charities for annuitant/donors.
Charitable gift annuities may be immediate, deferred, or flexible in the timing of payouts. There may be one or more annuitants. Multiple annuitants may be paid on the survivorship principle or as joint holders.
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