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December 01, 2009 at 02:00 AM
The holiday season often brings out the best in us. December is historically the peak month for charitable donations, but in today’s economy, charities, like retailers, are hoping the holiday season will serve another purpose–help them make up for lost ground.
The recession has made gifts that benefit both the charity and the donor more attractive than ever before. One of those gifts, a charitable gift annuity (CGA), returns a pension-like income stream back to the donor (and/or to another person). In today’s low-interest-rate environment, charities find themselves in a unique position and are advertising returns double or triple those offered by your typical certificate of deposit. Who wouldn’t want to possibly receive better returns while making life better for others? But before your client writes that check, be sure to review with him or her some best practices for evaluating CGAs.
The Benefits of CGAs
CGAs are very similar to charitable remainder annuity trusts, but they come free of the complexity associated with those vehicles. A donor makes a gift directly to the charity in return for the promise of a lifetime fixed income stream. The donor can start to receive benefits immediately or defer them for several years. For those who itemize deductions, the donation may provide an income tax deduction based on the difference between the donation and the present value of the projected annuity payments.
CGAs are also popular with charities. A quick Internet search will list programs offered by community foundations, colleges, museums, religious organizations, hospitals, social service organizations, and other nonprofit organizations. While the details vary among programs, the annuity rates tend to be standardized. Since 1927, the American Council on Gift Annuities (ACGA) has published suggested CGA rates for use by charities and their donors. Standardization allows smaller charities to compete with larger ones and helps makes the donor’s decision less about the best rate and more about the charity’s mission.
Understanding the Fine Print
The problem with CGAs is that there are several common misconceptions donors have about how they work. Some of the misunderstanding can be caused by an organization’s own planned giving materials. Here is an example of one college’s advertising:
By establishing a charitable gift, you can assure yourself of a fixed amount of income for the rest of your life. Ultimately, the principal used to generate income through any of these gifts will benefit the College. Establishing a charitable gift annuity is a great way to move funds from mature certificates of deposit (CDs), bonds, or appreciated stock into an instrument that will pay you an attractive interest rate with tax benefits.
For the philanthropic investor, this seems fairly straightforward, right? Unfortunately, this and other CGA advertisements can raise several red flags, in fact, there are four major misconceptions that we should address.
Misconception #1: An annuity rate and an interest rate are interchangeable terms.
You can see how a donor might assume that the college will preserve the entire donation for its charitable use while paying its current invested income to the donor. In fact, a portion of each payment is a tax-free return of the donor’s principal. Annuity rates are based on the age of the donor(s) and the assumption that the charity will realize approximately 50% of the gift when the donor dies. The older the donor, the greater the annuity rate, but the interest rate assumption stays the same.
In 2009, the underlying assumed interest rate for calculating CGAs is 5.75%. When a 78-year-old donor is quoted a CGA annuity rate of 7.2% on a $100,000 gift, the charity will pay him or her $7,200 a year for life.
