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Charitable Annuities: A Useful Tool for Some Retirees

A charitable gift annuity is a legal agreement between a donor and a charity that includes the following terms: As a donor, you make a significant charitable contribution in cash, securities, or other assets. In exchange, you are eligible for a partial tax deduction for your donation and a fixed stream of income from the charity for the rest of your life. “It’s appealing to some donors because they want to support their favorite charity but don’t think they can afford to lose cash flow,” said Larry Harris, director of tax services at Parsec Financial in Asheville, North Carolina. However, unlike charitable remainder trusts, these annuities can often be set up for free. How It Works Many prominent nonprofit organizations, including several universities, offer charitable gift annuities. First, you make a single charitable donation. The gift is then placed in a reserve account and invested. Depending on your age at the time of the gift, you will receive a fixed monthly or quarterly payment (usually supported by an investment account) for the rest of your life. The remainder of the gift is given to the charity at the end of your life (and your spouse’s life, if you’re giving as a couple). Individuals or couples can establish a charitable gift annuity. (You are the “annuitants,” which is the legal term for annuity and insurance policy beneficiaries.) Depending on the charity, you can fund your annuity with monetary contributions, securities, or personal property. Minimum gifts for establishing a charitable gift annuity can be as low as $5,000. However, they are usually much larger (50,000), and there is an age requirement (i.e., 60). Annuitants may be eligible for a tax deduction at the time of the original gift, in addition to the income stream, based on the estimated amount that will eventually go to the charity after all annuity payments have been made. Based on your statistical life expectancy, a portion of your payments may also be tax-free. When you gift to a nonprofit, the annuity contract shows you what your fixed payout will be in the future (possibly monthly or quarterly), based on factors such as your age and life expectancy and typically derived from payout guidelines issued by the American Council of Gift Annuities. For instance, a 60-year-old donating $10,000 may receive a payout rate of 4.4% ($440 per year), whereas an 85-year-old may receive a payout rate of 7.8% ($780 per year) for the same gift. Some nonprofits will also give you a higher rate if you postpone your payment start date for several years. Important Considerations Suppose you are only (or primarily) interested in maximizing guaranteed lifetime income. In that case, this type of annuity may not be for you. “This option is less appealing if the donor lacks a strong desire to make a charitable bequest,” Herzberg said. Income rates are generally lower than standard insurance annuities. Furthermore, as with any annuity, your guaranteed lifetime income is only guaranteed as long as the issuer remains solvent. In other words, the charity you donate should be financially stable. Furthermore, once you make the gift, you usually cannot get it back (other than the agreed-upon payments). The payments are also fixed, so there is no inflation adjustment as there may be with other annuities. Also, if you want to give money to more than one charity, remember that the gift annuity contract only works with one. “It’s a great tool if you want to help your charity but don’t want to give all of your money at once,” Harris said. Taxes You might be eligible for a partial charitable deduction for the year the charitable gift annuity is established. Why is there only a partial deduction? One portion of your contribution is treated by the IRS as a gift, to be used immediately by the charity for tax-deductible charitable purposes. The remainder is considered an investment for you, eventually generating your payments. A second tax advantage may be obtained by donating long-term appreciated stock or other property if the charity accepts these assets instead of cash. Reducing or eliminating capital gains tax is possible by donating non-cash assets directly rather than selling them first and then donating the proceeds. This capital gains tax benefit is not limited to establishing a charitable gift annuity. It also applies when you donate long-term appreciated securities or personal property to any public charity, including Fidelity Charitable. However, there is a potential tax disadvantage to a charitable gift annuity: a portion of your annuity income is taxable at the federal and state levels, depending on whether your state has an income tax. Because the rules can be complicated, consult with a tax advisor about your specific situation. Advantages of a Charitable Gift Annuity • A permanent source of income for the remainder of one’s life • Immediate (partial) tax deduction based on your expected life expectancy and income stream • The possibility of a tax-free portion of the income stream • The ability to donate various assets, including cash, securities, and personal property. • Capital gains tax liability reduced or eliminated for gifts of appreciated securities and personal property • Contributing to a worthwhile cause  Disadvantages of a Charitable Gift Annuity • Parting with funds donated to create the annuity in an irreversible way • The income stream is subject to income tax (payments from the annuity) • Payments are fixed and will not be adjusted to account for inflation. • Because the primary purpose is nonprofit support, payments may be lower than with a non-charitable annuity. • Cannot be used to support multiple nonprofit organizations unless multiple annuities are established.
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