Understanding Gift Annuities
By James B. Potter

If you understand charitable gift annuities, you can better market them to the definable target audiences which you are most likely to be interested in making such a gift to your organization. Here are some concepts and ideas that will help you in using gift annuities to expand your development program.

1. The usual target audience for immediate gift annuities (payments to begin within a year after the gift) is age 65 and up. Most organizations find that approximately 85 percent or their immediate annuity gifts are made by donors age 75 and higher. Gift annuities pay fixed payments for life based on the actuarial age (to nearest birthday of the one or two annuitants) on the gift date. TIP: Promote gift annuity rate for age of annuitant six months before his or her next birthday. Publicize that he or she qualifies for that higher rate six months before the actual birthday.
   
   
2. The after-tax return of the gift annuity will be higher than the comparable investments because: a) The "cost" of the gift is reduced by the tax savings of the charitable deduction, and b) The "actuarial value" or "cost" (gift amount less the charitable deduction) of the gift is returned to the annuitant(s) in equal payments over their life expectancy as tax-free return of principal payments. If the gift is appreciated property, a portion of the tax-free payments will have to be reported as capital gain income.
   
   
3. The capital gain tax is for a gift of appreciated securities is reduced and reported over the life expectancy of the donor if the donor is one of the annuitants. The donor reports only the portion of the long-term capital gain that is the percent of the gift represented by the actuarial value of the gift. The portion of the gain attributable to the charitable deduction is forgiven. The reportable gain is reported as capital gain income in equal payments of the life expectancy of the donor only up to the amount of the tax-free payments each year. If annuitants die before all the reportable capital gain has been reported, any unreported balance in forgiven.
   
   
4. The usual target audience for deferred payment gift annuities (where the donor chooses the date payments are to begin at least a year after the gift date) is age 35-55, with deferral period usually 10 years or more, and payments starting at 60-65. Donors usually are most interested in the resulting annuity rate if the deferral period is 15-20 years or more. The calculated annuity rate remains fixed for life and is determined by multiplying the annuity rate effective for actuarial age on the date annuity begins (6 months before payments are to begin) by a deferral factor determined by the number of whole years of the deferral period determined from the gift date to the date six months before the payments are to start. TIP: To defer an annuity for ten years, make deferral period at least ten years and six months to get the benefit of a ten year deferral and not have it reduced to nine years.
   
   
5. A deferred payment gift annuity (DPGA) has sometimes been called "Charitable IRA" because of the high charitable deduction available if the deferral period a donor chooses is 15 years more. The charitable deduction can be 80 percent or more of the gift, making it an ideal shelter for a high income person who has already put the maximum amounts into his or her IRA, KEOGH, 401K or other retirement plan.
   
   A DPGA is not limited to donor amounts like the standard retirement plans. Donors are able to use the 50 percent or 30 percent of adjusted gross income of the charitable deduction amount, for a gift of cash or appreciated securities respectively, with a carryover of up to five additional tax years for any amount that cannot be used in the year of the gift. DPGAs are the most underutilized life income gift plan in the charity's arsenal. TIP: Promote the retirement planning benefits of DPGAs to high income professionals.
   
   
6. It is important that the principal of the gift grow as much as possible before the payments start, even as much as two or three times if the deferral period runs as long as 20 years. Rather than taking standard market risks of normal investments to accomplish this during the deferral period, invest in each DPGA in a zero coupon bond that will mature six months before the payments are to start. This avoids the market risk of standard investments.
   
   
7. You must publicize the maximum gift annuity rate you offer at each annuitant's age. You cannot negotiate each one separately with each donor as you can for separately invested remainder trusts. You can advise prospective donors that if they are willing to accept a rate lower than the one for their age, they will get a LARGER charitable deduction.
   
   Never offer gift annuity rates higher than the uniform gift annuity rates of the American Council on Gift Annuities (ACGA). If you do, you will have to pay the actuary to "prove" to most of these states that regulate annuity gifts by statute that, on average, your organization will net at least 50 percent of the gift. That is not only expensive to prove actuarially, but the chances are very high that you will not be able to do so. For information on uniform gift annuity rates, contact ACGA at 317-269-6271. Membership costs $75.00 annually.
   
   
8. Always invest the entire gift in your segregated (separately invested) gift annuity fund. Never spend any part of the gift before the termination of the annuity agreement. If you do, you will not be able to prove actuarially that, on average, at least 50 percent of the gift will accrue to your charity. All of the income on the invested 50 percent remainder is needed to make the payments. Your rates may not qualify in any of the 11 (soon to be more) regulated states that require you to obtain a permit.
   
   Consider obtaining a permit in at least one regulated state in which you have annuitants or if you have an office in that state. You then will know of the investment and other restrictions for administering a gift annuity fund. Also, be sure you are tracking the value of each annuity agreement within your fund, so you know the amount to with draw from your Fund at the demise of the last annuitant in each agreement.
   
   
9. As a rule, it is unwise to accept real property for a gift annuity for at least two reasons: a) It is not legal if you have or expect to get a permit from New York State, and b) The difference between the appraised value on which the annuity agreement must be written and the net proceeds of the sale you get to reinvest in your annuity fund is too large a risk for the charity to accept for that fixed payment plan. Gift annuity rates are determined using the assumption that all gifts are cash.
   
   When you view the conservative investment rules of most of the 11 (and growing number) of regulated states that presently require the charity to obtain a permit to accept annuity gifts from their residents, the risk of not being able to net 50 percent of the appraised value of the gift at the termination of the annuity contract is just too great. Rather, use an income-only version of the Charitable Remainder Unitrust for gifts of real property (and "flip" it to a "straight rate" Unitrust upon the sale of the property), which shares the risk of changes in value between the donor and charity.
   
   
10. Be sure to segregate your gift annuity fund - or at least the actuarially determined, annually changing, reserve portion of you gift annuity fund - from all other investments and funds of your organization. The required legal reserve portion of your fund must be invested in specific stocks and bonds acceptable to the guidelines of each regulating state. It may not be invested in mutual funds or as a part of your endowment fund, even if it is utilized and you can identify your annuity fund as a participation by its number of shares within a larger fund.
    

Unless you hold specific investments as a separate fund, your annuity fund will not qualify for a permit in any of the regulated states. Know the rules for investments and reinsurance for each of the regulated states in which you have annuitants or offices.

Gift annuity funds are not difficult to administer if you are aware of the state-mandated rules. Because they are contracts and not trusts, gift annuities are regulated by a growing number of states, not by the federal government. Network with other charities and contact the ACGA. Do not contact the state regulators (insurance departments) until you are ready to apply for a permit in their state.

Be aware of the "rules of the road" and you will be able to generate for your organization at least 50 percent of almost every annuity gift you receive. With the difference between annuity rates and interest rates in the market place, there is a real interest on the part of certain segments of your donor base, which you should be targeting for such gifts. See also the article in the May 1993 issue of Planned Giving Today on gift annuity policies, an important element of a good gift annuity program. (Go to http://www.PGToday.com. )

(^Top)