Gift Annuities: everything you need to know

August 3, 2020

If 2020 could be summarized in one word, we would propose this one: uncertainty. This seems to be the consistent theme of the year. For some, it is the uncertainty of work. For others, the uncertainty of the financial markets. And for all, the uncertainty of the COVID-19 virus and its spread throughout the United States and the world.

Even with all these uncertainties, there are some aspects of Goshen College about which we are certain, including our vibrant mission. You, GC alumni and friends, are making the mission possible through your generosity.

We need to continue to push forward and pursue goals we’ve set for ourselves and our families. Perhaps one of your goals is to provide a gift to Goshen College but, in doing so, you must consider the special circumstances that 2020 has delivered. In this environment, a concern for some donors is that a cash gift now could leave them short of future income. If you are a regular reader of the Newsletter, you know by now that there are many ways that donors can achieve their charitable interests while maintaining adequate future income to meet their individual or family needs.

In fact, often we can suggest specific life income plans that might increase spendable income for donors. Which brings us to the topic of this edition of the Newsletter: A charitable gift annuity is often the simplest and most realistic option for making a significant charitable contribution while maintaining future financial security. (On a side note: It is important that donors and investors not confuse commercial annuities with the benefits of charitable gift annuities. These two financial instruments, while both called annuities, are very different.)

If you have a desire to make an outright gift to Goshen College but are reluctant to relinquish an income-earning asset from your investment portfolio, a charitable gift annuity could be the perfect solution to achieving your goals.

What Is a Charitable Gift Annuity?

The concept of the charitable gift annuity in America dates to 1843, when a Boston merchant donated a gift of money to the American Bible Society in exchange for a flow of income. Today, the concept includes valuable tax benefits for donors. But perhaps more valuable than the financial advantages is the satisfaction donors gain by helping to continue the mission and good work of providing the unique and excellent Goshen College educational experience.

At the time of the annuitant’s death (or at the time of the second person’s death in joint and survivorship annuities), the portion of the donation remaining becomes available for the work of Goshen College.A charitable gift annuity is a simple agreement whereby a donor makes an irrevocable gift to Goshen College and in return receives a regular flow of income for as long as he/she lives. The College will pay a fixed income on a regular basis (usually quarterly) for the donor’s lifetime (and a survivor’s if desired), based on the amount of the gift, the donor’s age (and, if applicable, the age of the survivor beneficiary) and according to the rate offered at the time the annuity begins. Goshen College, like many other institutions, uses the rates suggested by the American Council on Gift Annuities.

The plan allows a donor to make a substantial gift without losing the benefit of the income the capital is earning. In fact, when the tax advantages are considered, many donors find their net return is higher through a gift annuity.

Benefits of a Gift Annuity

Besides the satisfaction derived from making a major investment in the future of Goshen College, a donor enjoys the following benefits:

Guaranteed annual income. An annual payment guaranteed for life and backed up by all the assets of Goshen College.
Immediate charitable deduction. A charitable deduction for Federal income tax purposes in the year the gift is made to establish the annuity. Since the donor will be receiving lifetime income, the deduction is less than the full amount of the gift, determined according to I.R.S. tables.

Reduced annual Federal income taxes. A portion of the amount the donor receives each year from the annuity is exempt from Federal income taxes. (Federal tables specify this tax-free portion as a return of principal.) The amount is determined by the donor’s life expectancy based upon the donor’s age at the time the gift is made.
Reduced capital gains taxes. This occurs when long-term appreciated assets such as securities or real estate are used to fund the annuity. The amount of the capital gains tax is less than it would be if the same long-term appreciated property were sold and the proceeds donated to Goshen College. Also, the capital gains tax may be paid over a period of years if certain conditions are met.
Freedom from the worries of investment management. Goshen College’s registered financial advisors and managers invest the funds and constantly monitor all investments closely. The College uses Everence Foundation to manage its gift annuity pool.
Reduced estate tax liability. Removing the amount donated to the College from the donor’s taxable estate may result in lower estate taxes and reduced probate costs.
Supporting an institution you care about. Above all, creating a charitable gift annuity enables a donor to transfer assets to the College now and receive the satisfaction of making a substantial impact on the college’s mission while retaining, during the donor’s lifetime, a desired flow of income.

An Example of a Charitable Gift Annuity

Here is a hypothetical example of the implications of a charitable gift annuity:

Mr. Yoder, age 70, wishes to make a gift of $50,000 to Goshen College. His estate is not large, and he has determined that he needs the income which would likely be provided if the $50,000 were invested in the market. Mr. Yoder agrees to irrevocably transfer $50,000 to the College in exchange for a charitable gift annuity. In return, we agree to pay him for his lifetime an annual annuity of 4.7% of the principal amount at the time of gift, or $2,350 per year, in quarterly installments.

Depending on the type of asset contributed, a portion of Mr. Yoder’s payment will be taxable to him as a combination of ordinary income, long-term capital gain, and tax-free return of principal. In each of the next 15 year’s payments of $2,350 will contain $2,007 of tax-free income and $343 of ordinary income. All income will be ordinary after 15.8 years, his projected life expectancy.

Income Tax Deduction

As its name implies, a charitable gift annuity is part charitable gift and part purchase of an annuity contract. The gift portion of Mr. Yoder’s transfer is deductible for income tax purposes. Based on the information above, his charitable deduction would be $18,282.

The tax rules limit the amount of tax-free payments Mr. Yoder will have each year. This limit will vary based on his income and the type of asset contributed. We would be pleased to discuss the application of these rules to your specific circumstances.

How a Charitable Gift Annuity May Apply to You

Here is a table showing other ages, the current annuity rate, the amount of the charitable deduction, and the tax-free portion of the annual income for a one-life annuity of $50,000:

For a Gift Annuity of $50,000

Age of

Donor

Rate of

Return

Annual

Income

Tax Free Portion of Annual Income

Amount of Charitable Deduction in Year of Gift

3.3%

3.7%

3.9%

4.2%

4.7%

5.4%

6.5%

7.6%

8.6%

$1,650

1,850

1,950

2,100

2,350

2,700

3,250

3,800

4,300

$ 1,353

1,524

1,619

1,764

2,007

2,330

2,837

3,424

3,926

$ 5,466

6,715

11,151

15,089

18,282

21,329

23,622

27,066

31,147

Note: (1) The above rates of return are based on Uniform Gift Annuity Rates as adopted by the American Council ‘on Gift Annuities. (2) All tax calculations in this newsletter reflect an Applicable Federal Rate (AFR) of 0.6%, as of June 2020; these Federal interest rates change each month. The annuity is paid in semi-annual installments.

Establishing a Gift Annuity Through A Transfer of Appreciated Securities

Additional benefits accrue to the donor if the gift annuity is funded with long-term appreciated securities.

For an example of the impact of such a gift, let us assume that Mr. Yoder in the example given above creates the gift annuity with long-term appreciated securities which today are worth $50,000, but which cost Mr. Yoder $20,000 when he purchased them. If he were to sell them instead of giving them to Goshen College, he would have a capital gain of $30,000. By transferring the securities to a gift annuity, the capital gain is reduced to $19,031. Further, Mr. Yoder may prorate the gain over his life expectancy of 15.8 years, thereby reducing the capital gain amount reportable annually to $1,204 ($343 in ordinary income is also reported during this period). Mr. Yoder could also likely increase his income from the securities if they are presently paying dividends of less than 4.7%.

How a Two-Life Gift Annuity Works

A gift annuity may be established for two lives, meaning that the annual annuity payments will continue for the lives of two persons. For example, a husband and wife may create a gift annuity specifying that regardless of who dies first, the annual income will be paid to the survivor as long as he or she lives. Here is an example:

Mr. and Mrs. Blue establish a gift annuity through the transfer of $35,000 in cash to Goshen College. At the time the gift is made, Mr. Blue is 65 years of age, and Mrs. Blue is 60. The calculated annual rate of return is 3.7%, yielding an annual income to Mr. and Mrs. Blue of $1,295. This annual income is paid in regular semi-annual payments for the lifetimes of both Mr. and Mrs. Blue. If, for example, Mr. Blue should pass away three years from now, Mrs. Blue will still receive the annual income of $1,295 for her remaining years.

In the year the gift annuity is established, Mr. and Mrs. Blue are entitled to a charitable deduction of $4,945 on their Federal income taxes. Of their annual income of $1,295 each year, $1,097 of it is tax-free.

How to Defer Additional Income For Retirement (The Deferred Payment Gift Annuity)

For a person who has adequate current income, but wants to provide for more future income, there is a variation of the charitable gift annuity called the deferred payment gift annuity. Such an arrangement works like this:

A donor irrevocably transfers cash or long-term appreciated assets to Goshen College, specifying that the guaranteed annual income payments begin at some specific future date (usually, upon the donor’s retirement). The income tax charitable deduction is claimed now, in the year the agreement is made. The rate of return to which the donor may be entitled may be considerably higher than if the donor began taking payments immediately.

Here is an example:

Mrs. Kindly is an executive with a large corporation, earning a substantial annual income which places her in the 37% income tax bracket. She has no need for additional income now but knows that she will need more income after she retires, when she will be no longer earning a large salary. She is 58 now, and will retire in 8 years, at age 66.

She donates $100,000 in cash to Goshen College in exchange for a deferred payment gift annuity which will pay her an annual income of $6,000 payable in equal installments at the end of each semi-annual period, beginning when she is 66 years old. A portion of this income, $1,638, will be taxable, the remaining $4,362 is tax-free, based on current tables.

This year, she is entitled to claim a charitable deduction of $17,087 on her Federal income taxes. Because she is in the 37% tax bracket, she saves $4,362 in Federal income taxes this year. If she cannot claim the total deduction this year, she can carry forward the remainder over the next five years.

How the Funds are Used by Goshen College

The principal received by Goshen College from a donor in exchange for a charitable gift annuity or a deferred payment gift annuity is held for the lifetime of the donor (and surviving beneficiary) in order to ensure the annual income payments. Upon the death of the last survivor of the annuity agreement, the principal becomes available for use by the College as determined by pre-arrangement with the donor or, if the donor did not specify usage, by the College’s administration and Board of Directors.

Gift annuity proceeds can be added to the Goshen College endowment funds, thereby establishing annual benefits for Goshen College and a gift in perpetuity by the donor. The donor may also express a special interest in the use of these funds, such as a named fund, a scholarship fund, faculty support fund, program endowment, etc. Proceeds could also be used to help the College with current critical needs that exist when the distribution is made to the College.

In Conclusion

The charitable gift annuity and the deferred payment gift annuity offer many advantages to the person who wishes to make a major investment in our work:

opportunity to increase fixed income;
opportunity for tax-free income;
higher after-tax return than a certificate of deposit, savings account, money market fund, and some bonds or low-dividend-paying stock;
reduced capital gains tax if annuity is established using appreciated assets;
freedom from investment management worries;
an immediate income tax deduction;
capital gains tax liability spread over life expectancy; and
reduced estate tax liability and probate costs.

When contemplating any planned gift, you should always consult your own legal and financial advisors to help you determine if such a gift is appropriate for your own circumstances.

We would be pleased to visit with you about a charitable gift annuity or to send you specific proposals appropriate to your interests. If we can help, please contact us by email or phone. You can find more information on planned giving on our website at https://www.goshen.edu/give/give-goshen-college/planned-gifts/. Or you can enter your age(s) and gift amount at https://www.goshen.edu/give/give-goshen-college/planned-gifts/calculator/ and see for yourself how a gift annuity can benefit you and Goshen College.

We will hold any information shared or any questions asked in the strictest confidence. If you have questions, or would like additional information about gift annuities or our mission and programs, please contact me or one of the others in the College’s Advancement office.

Roger A. Nafziger
Director of Gift Planning
rogeran@goshen.edu
Ph: (574) 535-7797