Thoughts on Elderlaw- What are Gift Annuities?

The cruelest month, April, is behind us, but some memories of its indignities may linger.  Perhaps tax bills are still in our minds, and we wonder what, if anything, we can do to make them less unpleasant next year.  Maybe I can be more generous to charities and obtain a larger charitable deduction from my income tax.  Of course, money that I give to charity is just as lost to me as money that I pay to the government, but perhaps I will have warmer feelings about that loss.

With proper advice I can also make a charitable contribution less financially onerous than it might first appear.  Suppose that a charitable organization or cause in which I have long had an interest convinces me that a gift of, say, $30,000 would do a lot of good, and that I can afford to make such a contribution.  I can write a gift of $30,000 into my will but that is not going to help the charity for what I hope will be quite a while, and it will not save me any income tax, which is what I have started thinking about.

I can instead write a check for $30,000.  That will give me an income tax deduction (I am, of course, assuming that the charity in which I am interested is a “501(c)(3) organization”, gifts to which are deductible for income tax purposes).  This will reduce my tax bill for next year and maybe beyond if I can carry some of the deduction forward, but I will have parted with $30,000, as well as any income I might have earned by investing that amount.  Only the tax deduction and my warm feelings remain to comfort me.  Can I do good and feel good while giving up very little, if any, of my present financial security?

Suppose I own stock now worth $30,000 that I bought some years ago for $15,000.  The stock pays a 2% dividend, or $600 per year.  If I sell the stock in order to reinvest in something that has a higher return I will incur a significant taxable capital gain.  Instead I transfer the stock to my charity in return for the charity’s promise to pay my wife and me a set amount until the death of the survivor of us.  The charity makes an irrevocable contractual promise, secured by all its assets, to pay this annuity at a rate that will be set at the time of the gift, and will not change thereafter.  That rate will be based on our life expectancies at the time of the transfer.  At our present ages the rate will probably be in the vicinity of 6%, triple the amount of income presently being produced by the stock.

There are a number of ways in which transfers of property can be made to charity, while the donor retains an interest in the income produced by the property.  The charitable gift annuity described here is probably the easiest.  Because I am making a present gift to charity of the amount that remains after the lifetime payments to me and my wife have been made, I am entitled to a charitable deduction from income tax.  The amount of the deduction will be the amount I transferred to the charity ($30,000) less the value of my and my wife’s retained interests based on our life expectancies and the rate of interest to be paid us.  In our case the deductible amount would probably be about 60% of the amount transferred.  That deduction will reduce the amount of tax I will pay next year, and perhaps in subsequent years if I can carry some of the deduction forward, thus giving me more spendable income.

The annual payments I receive will be taxed favorably.  A portion of each payment will be regarded as a return of capital and therefore income tax free until the expiration of our life expectancies.  Another portion is taxed at favorable capital gains rates, again until the expiration of our life expectancies.  During our life expectancies only the rest of each payment will be taxed as ordinary income.

This transaction allows me to benefit a favorite charity while reducing my income tax.  In my hypothetical example I can triple my annual income from the donated assets, and, instead of that income all being taxed at ordinary income rates, some will be tax free, and some taxed at more favorable capital gains rates.  This may be worth considering.

– – Written by resident Ned Henneman


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