Sooner or later, you're going to get a call from a valued client that may put you in an uncomfortable situation. He will tell you that the Society for Preservation of Historically Significant Manhole Covers (an organization of which he is particularly fond) is in the middle of a heated fundraising campaign, and has asked for his help.
The members are not just requesting money, though — they're offering to give some back in the form of a charitable-gift annuity. He then inquires as to your opinion of the maneuver in general, and more specifically, of the charitable-gift annuity,.
Proclaiming ignorance of the vehicles, or worse yet, obstructing the process as if the money were your own, will only sink your status in his eyes. Instead, here is what you (and your client) need to know about charitable-gift annuities, and why CGAs should or shouldn't be a part of a client's overall financial plan.
Tax Deduction Now
A charitable-gift annuity allows a client to donate money or securities to a qualified organization in return for a tax-deduction now, and the possibility of tax-favored income from the charity in the future.
The tax deduction for the donation is determined by taking the amount of the contribution, then subtracting the present value of the future payments to be made to the donor and/or beneficiaries.
Other factors that will be used to calculate the potential deduction include the IRS tables on life expectancy, the assumed earnings and the current gift-annuity rate. Can't run the numbers off the top of your head? Then start with the calculator available at http://pcalc.ptec.com/hosts/989357365/CGA/simple.html?immediateOrDeferred=I.
Income Starting Now (Or Later)
Like traditional immediate or deferred annuities, donors can either choose to begin payments from a CGA now, or at some point down the road. They can choose to name either one or two beneficiaries, and can choose someone else as the beneficiary as well. The payments will continue for the life of the beneficiaries. The amounts are determined by the size of the gift, the life expectancy of the beneficiaries, and the interest rate used by the charitable organization.
Although the charity can use any rate it chooses to set the payout schedule (as long as the rate doesn't exceed federal- or state-law limits), most use figures established by the American Council on Gift Annuities. Keep in mind that although these rates are intended to be conservative enough to ensure that the charity can meet its payment obligations to the beneficiaries, the charity's finances are usually the sole source of guarantee that the beneficiaries will receive their payments as promised.
Once the payments begin, they are fixed at a specified amount. A portion may be taxed as ordinary income and/or capital gain, but the rest is considered tax-free return of principal. This “exclusion ratio” is based on the type of asset donated (cash or appreciated property), whether the donor is also the beneficiary, and the life expectancy of the beneficiaries. If the beneficiary outlives the original life expectancy, the entire payments are then subject to taxation.
Example
Say your clients are a 65-year-old couple in the 28-percent tax bracket. They would like to give $100,000 in cash to a qualified charity in the form of a charitable-gift annuity. At the time of donation, the couple receives an immediate deduction of up to $26,506, potentially saving them up to $7,422 in federal income taxes. The charity gets the couple's $100,000 to further its particular mission.
If the clients choose to begin getting payments immediately, they will receive $5,600 per year until both have passed away, based on an applicable rate of 5.6 percent. About $2,900 of each year's $5,600 is tax-free, until one — or both — clients have outlived their pre-established life expectancy. After that, all the payments are subject to taxation.
Planning Opportunities
Certain clients will be more suited than others to consider using a charitable-gift annuity. First and foremost will be those who have a desire to help a particular charity right now, with the added tax and income benefits serving as icing on the proverbial cake.
Benevolent retired clients looking for income are natural candidates, especially those who are blessed with the good genes and a healthy outlook that may allow them to outlive the ages proscribed in the life-expectancy tables.
And the older they are, the higher the applicable rate will be, and the more income they will receive. Since a good portion of that income may be tax-free at first, they could then get deductions for which they might not otherwise qualify, or keep Social Security benefits from being taxed.
Say the couple above was looking to provide not just for a favorite charity, but for a beloved 5-year-old grandson as well. By naming the little tyke as the sole beneficiary of the immediate payments, the kid would get about $3,900 per year for life.
But gifting CGA strategies are not just limited to the “older” providing for the “younger.” If the same couple wanted to help a 70-year-old friend or relative by naming her the beneficiary, she would receive about $6,500 per year for life.
And in either of the above cases, the donor still gets the tax deduction. You should caution your clients, though, that any doubly benevolent acts may trigger gift-tax consequences, and that they should consult their tax- or estate-planning advisor to evaluate the idea first.
More Information
Once the CPA and attorney have signed off on a CGA for your client, he needs to decide exactly who should benefit from his largesse. Visit the website of the aforementioned American Council on Charitable Gift Annuities at www.acga-web.org to find out more about the process, and which ones can accept money contributed this way.
After that, the chosen charity takes over all the devilish details and paperwork. In other words, all you have to do to at least appear to be generous at heart is to offer your general guidance.
Writer's BIO: Kevin McKinley CFP is a Vice President-Private Wealth Management at Robert W. Baird & Co., and the author of the book Make Your Kid a Millionaire (Simon & Schuster). You can reach him at [email protected]