Uncertainty over future living expenses and life expectancy may cause some individuals to postpone donations to charity. This ultimately stems from the concern that they may outlive their savings. For some, a charitable gift annuity may be a creative way to contribute to charity while addressing the need for income.
This method of planned giving requires an understanding of annuities and their differing features. The most common are term annuities and life annuities. Term annuities are issued for a certain period of time. As life expectancy is unknown, it is more common to see life annuities in these structures.
A life annuity generally provides a determined amount of payments for the individual’s lifetime. When a life annuity is first purchased, certain guarantees may be selected to ensure that a specified amount is to be paid from the annuity to the individual. The following are important points to consider:
- Longer guarantee periods have a negative impact on the level amount of payments (standard guarantee periods are 10 or 20 years).
- Payment amounts may be paid out based on the individual’s needs (i.e. monthly, quarterly or annually).
- Payments may be taxed on a prescribed basis. This means that a portion of each payment received is considered a return of capital (which is not taxed) and the remaining portion is considered income (which is the taxable portion).
Two very important points to consider are:
- Once an annuity is purchased, the original capital is not returned.
- Once an annuity is established it cannot be revoked.
Individuals may purchase an annuity directly or through a charity. When purchased through a charity, it is often referred to as charitable gift annuity. To make the above structure advantageous for the charity, the total donation amount must generally exceed the cost of the annuity. To be advantageous for the donor, the annuity amount cannot be more than 80 per cent or there is no gift receipt if it is done through a charity. Note: certain major charities self-insure the annuity component but most others reinsure (i.e. purchase an annuity from an insurance company).
Where to Start
- Look at cash flow needs: How much monthly is required to fund day-to-day expenses? Factor in reasonable inflation assumptions.
- Consider life expectancy. This includes current age, current health condition, lifestyle issues and family health history.
- Income levels and tax situation. Ensure the individual can utilize the benefits of any tax credits from the donation.
The next step is to look at annuity options and obtain a quote. Assuming that the individual requires income for the remainder of their life the big decision will come down to choosing a dollar amount and their guarantee period.
Benefits: There are several advantages to this type of planned giving:
- Cash flows are predictable
- Possible reduction on annual taxes
- Less risk with respect to other types of investments
- Reduction in ongoing investment advisory fees
- Eligible for donation receipt (amount will be the donation amount less the costs to purchase the annuity)
- Ability to give while the individual is alive
Mr. Lee, age 75; monthly cash flow requirement: $2,000; guarantee period: 10 years; amount considered: $300,000.
Mr. Lee sold a rental property for $400,000. He has decided to keep $125,000 for emergency savings. With the remaining $275,000 he is considering a charitable gift annuity. During our discussions Mr. Lee indicated he was receiving certain government and pension benefits that would be paid for the rest of his life. Mr. Lee also stated that he would like annuity income paying $1,500 per month (or $18,000 annually) for the rest of his life. Mr. Lee felt that these sources of income would be sufficient to meet his monthly cash flow needs even during times of inflation.
The premium for an annuity with a payment amount of $1,500 per month is approximately $192,000. Mr. Lee would begin receiving his $1,500 in one month and this would continue for the rest of his life. Although Mr. Lee is receiving $18,000 in annual annuity payments, the taxable portion is only $3,225. If the charity received $270,000 and had cash outlays of $190,000 for estimated annuity cost then the charitable donation receipt would be for the net amount of $80,000 less appropriate adjustments. This donation receipt may be useful in offsetting the tax liability that occurred from the sale of the rental property.
Charitable gift annuities are an attractive alternative for those wishing to make a planned gift to charity. The individual must be willing to make a lump sum donation realizing that a portion will be used to purchase an annuity. The annuity income stream, along with other available funds, must be sufficient to fund the individual’s expenses in order for this strategy to work.
Before implementing any strategy noted in our columns we recommend that individuals consult with their professional advisors (insurance consultant, financial advisor, accountant and estate lawyer).