Charitable Gift Annuities

Charitable Gift Annuities

Why Didn’t I Know That?

(My Moments of Humble Pie)

&

1.

Annuity payments can vary from standard calendar periods

Quarterly payments are NOT required to occur in Mar., Jun., Sept., Dec.

Why Didn’t I know That?

2.

Determining how much of the capital gain is avoided

It is equal to the charitable deduction!

3.

Gift Annuities involve THREE life-expectancy tables

“After XX.Y years, the entire annuity becomes taxable.”

Age 70 Donor

ACGA Annuity Rate based on Annuity 2000 female life expectancies: @ 70 = 18.8 Yrs. @ 69 = 19.6 Yrs.

Deduction calculated based on 2000CM Unisex table: 14.2 Yrs.

4.

Payments from an Immediate Payment CGA DON’T have to begin immediately!

With or Without Make-up

Why You Might Do This:

Desire to defer income into another tax year

Coordinate the start of payments with the sale of an asset

Tax deduction for current year

5.

No Assignment of Annuity Interest? – Frank Minton Says “Should Be Permissible”

“This annuity is irrevocable and non-assignable,…”

The reason for including such language is so that capital gain (in the event appreciate property is

contributed and the donor is an annuitant) can be reported ratably over the donor’s life expectance.

If a donor contributes cash, or contributes appreciated property

and is willing to forego ratable reporting of gain,

language permitting the assignment of the annuity to another individual

should be permissible (assuming it is allowed under state law).

IRC Sec. 514(c)(5)(B) requires that the annuity “is payable over the life of one individual in being

at the time the annuity is issued, or over the lives of two individuals in being at such time.”

This language does not permit any change in the measuring life or lives,

but it does not appear to preclude assigning the payments to someone else.

6.

Flexible Deferred Gift Annuity Starting Date

Can be “Any Time” Within the Range of Starting Dates.

The PLR Request:

In 1997, at the request of Frank Minton and David Newman, submitted a Private Letter Ruling request on behalf of The Seattle Foundation for the following fact situation:

“...The annuity contract allows the annuitant to elect the commencement date of the payments under the annuity

at any time

after the annuitant, who is currently age 50, reaches age 55. When this election is made…”

Private Letter Ruling 9743054

…we rule as follows:

1. The issuance of a deferred charitable gift annuity, as described above… 3. The annuity contract issued by the Foundation, as described above…

From Charitable Gift Annuities, The Complete Resource Manual by Frank Minton

“Note: It is recommended(emphasis added) that the gift annuity agreement specify the month and day

on which the first payment would be made for each year in the range of yes… He didn’t write: “It is required…”

IMPORTANT Suggestion: When the Annuity is established, print out and keep in the file future payment schedules for all optional payment sequences, as it is difficult or impossible to recreate those schedules at a later date!

I’m Just Asking: Since the PLR request did not ask about a “mandatory” annuity payment starting date (i.e., no later than),

7.

CGA funded for “Domestic Helper/Employee” is NOT a Gift!

A gift annuity funded by a donor to benefit a faithful employee is considered compensation rather than a gift.

The Good News

The entire amount used to fund the CGA is deductible by the Donor/Employer: The gift portion is deductible as a charitable gift.

The present value of the future annuity payments is deductible as wages. EE’s annual payment will be taxed like a traditional annuity payment.

The Bad News : Withholding

The present value of the future annuity payments is subject to normal withholding.

The Worse News : A Tax Bill

The present value of the future annuity payments must be recognized as income by the employee in the year the CGA is funded, resulting in a substantial tax bill.

Prince Charming & Cinderella: The Real the Story

PC gives $100,000 to fund a 4.7% retirement annuity for Cindy, now 65. $32,206 is deductible as a charitable gift.

$67,794 (PV of the future payments) is deductible as wages. PC’s withholding: 6.2% + Taxes

PC’s gift lifted Cindy into a 30% tax rate. Her bill: $20,338

9.

Donor retains the right to turn on the Flexible Annuity payments

for a Non-Donor Beneficiary

Scenario: Sibling “A” wants to provide for Sibling “B” but is uncertain when payments should begin.

Tax Implications:

Donor is entitled to charitable deduction at funding.

Annual payments qualify for annual exclusion IF donor retains right to revoke.

Have You Ever Wondered:

Can a Flexible Gift Annuity have a Flip Provision?

Case Scenario 1

Spouse 1 wants to provide

income for a surviving spouse,

with payments to begin on the

death of Spouse 1.

Benefits

(A)

Avoids the issues funding and timing associated with a testamentary CGA.

Eliminates uncertainty associated with verbal “agreements.”

Case Scenario 2

Time the annuity

payments to start

with the sale of an

appreciated Asset

So, I asked two prominent attorneys and, after thinking about it,

they responded with an emphatic, “Probably.”

“…there isn’t a lot of authority (either way) with respect to the issue.

On the one hand, I haven’t found anything that would prohibit what you propose.

Alternatively, I haven’t found anything that would sanction what you propose.

Therefore, I can’t tell you that what you want to do isn’t permissible under the law.”

“In sum, I can’t point to any authority that unequivocally states that a flip provision is

either permissible or impermissible. As a result,

with the understanding that we are in uncharted waters, I would say that it should be ok.”

“…I think that CMC can, in good faith, take the position that the change is not a material one and,

therefore, pre-approval of the CA Dept. of Insurance was not required.”

Primary Concern

…IRS or CA Dept. of Insurance could find some way to object…because it is something

they are not used to seeing…They could take the position that it could lead to an unfavorable benefit

for a charity. Example, they could claim that the charity might make a half-hearted attempt

to sell property for many years in the hopes that the charity will not have to make annuity payments.

Possible Negative Consequences

Dept. of Insur.:

Could take the position the provision is not acceptable and force charity to rescind the CGA.

IRS:

A slim chance that they could conclude that the contract does not satisfy IRC Sect 514(c)(5) (which defines

a CGA) and is therefore, akin to providing commercial-type insurance, which is forbidden by IRC 501(m).

Violating 501(m) can potentially jeopardize a charity’s tax exempt status ifthe prohibited activity is more than

Insubstantial. Alternativey, they could assert that any income from the FLEX is UBTI.

a

CREATIVE APPLICATION 1

Virtual Endowment Gift Annuity

Better that a tax-free municipal bond?

How It Works:

1. Donor/Bene. keeps the tax-free portion of the annuity payment payment.

2. Donor/Bene. donates the taxable portion of the annuity payment back to the Charity

.

3. CGA remainder creates an endowed fund.

CREATIVE APPLICATION 2

Gift Annuity Funded with the Net Proceeds

from a Sale of Appreciated Assets

Biggest concern of issuing CGAs funded with real estate or other illiquid assets

is the question of the actual amount of cash the charity will receive.

Traditional solution is to discount:

X% for selling expenses

Y% for market risk

Solution to the Uncertainty:

Base the annuity payment on the NET SALE Proceeds

Case Study:

Donor Age: 69 Gift Annuity Rate: 5.0% Appraised Value: $450,000 Cost Basis: $175,000 Selling Expenses: $36,000 Net Sale Proceeds: $414,000 Capital Gain:

Calculations:

Annuity Payment: $414,000 x 5.0% = $20,700

Key Issue:

IRC 514(c)(5) excludes from the

definition on indebtedness CGAs

that meet 5 requirements:

#5:

CGA may not provide for

adjustment of the amount of the annuity

payments (emphasis added) by reference

to income received from the transferred

property. If the annuity payments vary

based on Net rental income from a

property, that clearly would not meet

the requirement.

The Question:

Are sale proceeds “income received

from the transferred property or, do

they merely establish the value of the

funding asset?

Reputable commentators have adopted

the view that “net sale proceeds

do NOT violate IRC 514(c)(5)

What if the IRS Disagrees?

Donor:

No negative tax implications

Charity:

Planning Issues

Gift Agreement

Donor signs a gift agreement in which the Donor the Donors) agree to fund a

charitable gift annuity with a gift of…

The Charity will deliver a gift annuity contract to the donors following the receipt

by the Charity of the net proceeds from sale of its interest in the Property.

Gift Date:

The gift date is the date on which an executed deed

transferring an interest in the Property is delivered to the Charity.

Gift Value:

The value of the gift is the appraised value of the Property,

determined by a qualified appraisal as defined in IRS regulations.

Annuity Payment Starting Date:

The Donor(s) and the Charity agree that the

annuity payment (crediting) period shall begin on the first day of the month following

the month in which the net sale proceeds from sale of its interest in the property are received by the Charity.

Annuity Structure

Immediate Annuity (with a deferred fist payment): If the assets sells in a timely fashion

the charity can issue an immediate-payment gift annuity.

Flexible Gift Annuity:

If the sale will close beyond 11 months following the gift,

the charity will issue a flexible gift annuity. The applicable annuity rate will be

the gift annuity rate as of the GIFT DATE, (without applying a deferral factor).

Charitable Deduction

If the sale will be delayed beyond March 31 of the year in which the donor would otherwise claim

the charitable deduction, a gift annuity will be issued based on the traditional discounting

CREATIVE APPLICATION 3

Charitable Pension Maximization

Help your donors maximize their retirement &

create a gift from a Defined Benefit Pension Plan

Choosing the Best Pension Option

The Single-Life Option

Joint-and-100% Option

$3,600

$2,880

$0

$2,880

Defined Benefit Pension Plans Still Exist!

New York Life Estimates there are 88 million plan participants (including cash balance plans).

14 million in state and county plans.

2.4 million in civil service plans (both CERS and FERS)

1.4 million members of the military

Monthly Pension Reduction (the “Spread”)

$720

In Summary

Married Retiree will pay $720 a month to guarantee

a monthly income of $2,880 to a surviving spouse.

THE KEY

What financial product can you think of

requires you to pay a monthly premium

LIFE INSURANCE!

Married Retirees routinely pay 10% to 20%

of their monthly pension to buy, what is, in effect,

LIFE INSURANCE!!

BTW: Can you think of another plan

where this same phenomena comes into play

?

Let me rephrase: if you are in one of these plans,

and you plan to provide for a surviving spouse,

YOU ARE GOING TO BUY LIFE INSURANCE;

The Joint & Survivor Option Problem

It only addresses one set of life circumstances:

Retiree predeceases his or her spouse!

1. What happens if the “Surviving Spouse” dies first?

Will the Retiree’s benefit “Pop Up” to the single-life benefit amount?:

NO

Can the retiree name a new beneficiary to receive the “survivor” benefit?”:

NO

Can the retiree get a refund for the “premiums” paid?:

NO

Total paid (in our example) over: 10 years - $86,000; 20 Years $192,000

2. What happens if there is a “simultaneous death” or “death in close proximity?

Since there is no “surviving spouse” no one will receive anything?

3. What happens if the Retiree lives 20 years and then predeceases the Surviving Spouse?

Is the Surviving Spouse’s benefit indexed for inflation:

NO

Is the Surviving Spouse’s benefit FULLY taxable:

YES

What is the Surviving Spouse’s remaining life expectancy (at age 85)? (7.7/8.3

)/2 Years?

Solving the Joint & Survivor Problem & Creating a Gift

1.

Retiree selects the Single-life Option (or perhaps the Jt. & 50% Option)

2.

Retiree uses some or all of the increased pension payment

to purchase a personally owned (

CASH VALUE

) life insurance policy.

3.

The (tax-free) insurance proceeds will be used to fund a gift annuity

(or a CRUT) payable to the Surviving Spouse.

RETIREE NOW OWNS & CONTROLS AN ASSET

The Charitable Pension Maximization Advantage:

FLEXIBILITY, OPTIONS & A GIFT

2. What happens if there is a “simultaneous death” or “death in close Proximity?

Life insurance policies have contingent beneficiary designations!

Can name heirs and/or charity.

1. What happens if the “Surviving Spouse” dies first?

Can the Retiree’s benefit “Pop Up” to the single-life benefit amount?:

YES

Can the retiree name a new beneficiary to receive the “survivor” benefit?”:

YES

Take a paid-up policy (or continue the policy)

and name children or a new spouse…or charity, a beneficiary.

Can the retiree get a refund for the “premiums” paid?:

YES (at least partial)

Option: Surrender the policy

Is the Surviving Spouse’s benefit indexed for inflation:

YES

Gift annuity rates are higher at the older attained age.

Option 1:

Use all of the insurance proceeds to provide income for Surviving Spouse.

Option 2:

Use some of the insurance proceeds to provide income for Surviving Spouse

and set aside the remaining proceeds for children.

Option 3:

Use the insurance proceeds to fund a CRUT for Surviving Spouse

and name children as contingent beneficiaries for a term of years.

Is the Surviving Spouse’s benefit FULLY taxable as ordinary income?:

NO

It is a gift annuity payment (or a CRUT payment).

Is it possible for the insurance premium to “vanish” after a term of years?:

YES

It is a gift annuity payment (or a CRUT payment).

Does Charitable Pension Max create a gift possibility?:

YES

1. P

urchase less insurance.

(A)

Depending on health and financial circumstances

the Surviving Spouse might not need the 100% benefit.

(B)

Could choose to take the risk that the Retireewill live long enough that

the attained age annuity rate will cover the smaller insurance amount.

(C)

Could opt for a CRUT if death occurs in early years.

2.

Maybe there is an investment portfolio that Retiree can use to make

a lump sum premium payment…or fund a FLEX DGA (with a flip provision?).

The increased rate at an older age and the flexibility might be

considered a good investment?

3.

Existing life insurance could be used or exchanged for a new policy?

(A)

An existing paid-up policy of one with a lower premium might offset the higher cost.

An existing cash value policy might be exchanged for

a new policy with the cash value acting as a lump sum premium payment.

(C)

Excess dividends from an old policy could be used to help pay for a new policy.

4.

May be willing to pay the extra amount for the flexibility

and the increased benefit to a surviving spouse

5.

The extra amount might be viewed as a

very inexpensive way to make a really large gift.

Structuring the Insurance Policy

The greatest flexibility occurs if the Retiree owns to policy.

Option 1:

Spouse as beneficiary

Option 2:

Charity is beneficiary with a gift agreement.

If estate taxes are an issue, transfer policy to an Irrevocable Life Insurance Trust

If the plan is to use a CRUT, then the CRUT can own the policy

and the premiums are partially tax-deductible.

Two-Life Gift Annuities & CPM

Ages 70 – 70 70 – 65 70 – 60 70 – 55 70 – 50 2-Life Rate 4.6% 4.4% 4.1% 3.8% 3.3% Age 70 Rate 5.1% 5.1% 5.1% 5.1% 5.1% Rate Reduct. .5% .7% 1.0% 1.3% 1.8% % Reduct. 9.8% 13.7% 19.6% 25.5% 35.2% Ages 65 - 65 65 – 60 65 – 55 65 – 50 65 - 45 2-Life Rate 4.2% 3.9% 3.8% 3.3% 2.9% Age 65 Rate 4.7% 4.7% 4.7% 4.7% 4.7% Rate Reduct. .5% .8% .9% 1.3% 1.8% % Reduct. 10.6% 17.2% 19.1% 27.6% 38.3%

When one beneficiary is significantly younger, the use of a

CRUT is probably the best alternative. Having the CRUT own the policy

makes the premiums partially tax deductible.

Donor can also use the charitable deduction tax savings to

make a lump sum premium payment to reduce the cost of the insurance.

BTW:

The Firm that Developed & Specializes in Pension Maximization is:

19787 NW Rock Creek Dr, Portland, OR 97229

(503) 690-0277

pensionconcepts.net

Jim and Rita Smith

Fact Finding Form:

http://www.pensionconcepts.net/forms.html

P

ension

CRUT Volatility Summary Analysis Comparison - 5%, 6%, 7%

Analysis Compares Variable CRUT Payments to a Fixed Payment Over 63 Twenty-Year Terms

(Assumes Historic "Blended" Returns for a Portfolio Composed of 70% S&P 500 and 30% Total Bond Returns: Similar to Kaspick & Co. Growth Portfolio)

63 Twenty-Year Terms from 1932 to 2013

NOTES:

Why Didn’t I Know That?

1. Annuity Payments Can Differ from Standard Calendar Periods

In most cases, annuity payments occur “at the end of the calendar quarter,” or “calendar year,” etc. However, it is fully permissible to make payments on a non-standard calendar schedule. Example: Feb/May/Aug/Nov.

2. How Do You Calculate How Much of Your Capital Gain is Avoided?

When you fund a gift annuity with appreciated stock, you are giving away a percentage of EVERY aspect of the asset, including the gain. Thus, if your charitable deduction is 15%, then you are also giving away 15% of the capital gain…so you don’t have to claim it.

3. Gift Annuity Calculations Involve THREE Life Expectancy Tables

Age 70 Annuity Rates are based on female life expectancies from Annuity 2000 18.8 Yrs Charitable Deduction is based on 2000CM 14.2 Yrs

Tax-free income term is based on 83Basic table 16.0 Yrs

4. Immediate Gift Annuity Payments DON’T have to begin…immediately!

The following is excerpted from Charitable Gift Annuities, The Complete Resource Manual by Frank Minton (chapter 2, pgs 2-3):

When or Why Might You Do This:

Desire to defer income into another tax year

Coordinate the start of payments with the sale of an asset Tax deduction for current year

With or without make-up

Can be illustrated on PG Calc

Methodology if you use the Taxation of Gift Annuity Payments illustration:

No Make-up: 1. In Gift Options you select Charitable Gift Annuity. 2. Answer Yes

to “Combine first partial payment…” This will give you the correct total income for the first year. 3. Select Custom Schedule. 4. Input date that first payment is to occur in Date first monthly

(quarterly) period ends:

With Make-up: The PG Calc system currently does not illustrate a combined

payment when the first payment is “deferred”. You will need to hand-calculate the figures. You would then need to edit the illustration in Word (or Excel) and insert the figures.

5. Assignment of Annuity Interest – Frank Minton Says “Should Be Permissible”

Case Scenario: 87 year-old aunt wanted to make a gift of cash to fund a CGA on her life (at a higher rate) and transfer the annuity payments to a

much younger niece over the rest of her (the donor’s) life. (Didn’t want to take the payments are write a check.)

The following is excerpted from Charitable Gift Annuities, The Complete Resource Manual by Frank Minton (chapter 2, pg 12):

“Gift annuity agreements typically include language such as the following: “This annuity is irrevocable and non-assignable, except that it may be assigned to the charity.” The reason for including such language is so that capital gain (in the event appreciate property is contributed and the

donor is an annuitant) can be reported ratably over the donor’s life expectance (emphasis added). See Reg. Sec. 1.1011-2(a)(4)(ii).

If the donor contributes cash, or contributes appreciated property and is willing to forego ratable reporting of gain, language permitting the

assignment of the annuity to another individual should be permissible (assuming it is allowed under state law).

IRC Sec. 514(c)(5)(B) requires that the annuity “is payable over the life of one individual in being at the time the annuity is issued, or over the lives of two individuals in being at such time.” This language does not permit any change in the measuring life or lives, but it does not appear to

preclude assigning the payments to someone else. For example, a donor might establish a gift annuity for A, reserving in the agreement the right

to revoke A’s payments and assign them to B. The payments would be made to B for the duration of A’s life. If A died after two years, payments to B would cease. It is not possible to assign the payments to B and have them continue for the duration of B’s life. The measuring life is stated in the agreement and cannot be changed. In the event that B predeceased A, the payments could revert to A if so stipulated in the assignment document.

Tax Note: If A had a right to the annuity payments and the power to assign them, and then assigned them to B, A would (probably) be taxed on

the payments made to B under the assignment of income doctrine.”

6. Flexible Deferred Gift Annuity Starting Date Can be “Any Time” Within the Range of Starting Dates.

The following is excerpted from Charitable Gift Annuities, The Complete Resource Manual by Frank Minton (chapter 18, pg. 2):

“Note: It is recommended that the gift annuity agreement specify the month and day on which the first payment would be made for each year in the range of years when payments may begin. For example, it would state that the annuitant could elect to start payments on the last day of March of any year between 2013 and 2023. Thus, the first payment would be not earlier than March 31, 2013 and not later than March 31, 2023. It may be that the annuitant turns age 65 in 2013 and age 75 in 2023, so he or she may elect payments between ages 65 and 75. However, the agreement will specify a range of dates rather than a range of ages at which payments may begin.”

Note that Mr. Minton did NOT use the word “required.”

Private Letter Request

In 1997, at the request of Frank Minton and David Newman, an attorney with Mitchell Silberberg & Knupp in Los Angeles submitted a Private Letter Ruling request on behalf of The Seattle Foundation for the following fact situation: “..The annuity contract allows the annuitant to elect the commencement date of the payments under the annuity at any time after the annuitant, who is currently age 50, reaches age 55. When this

Private Letter Ruling 9743054

Issued: August 1, 1997 Published: October 24, 1997

Dear Sir or Madam:

This is in reference to a ruling request dated February 20, 1997, concerning the federal tax consequences of the proposed transaction described below.

The information provided indicates that you (the “Foundation”) are a charitable organization described in section 501(c)(3) of the Internal Revenue Code. The foundation proposes to offer an annuity contract to B, an individual.

The proposed annuity contract would establish a deferred gift annuity, under which the donor makes a charitable contribution of $25,000 to the Foundation in exchange for the obligation of the Foundation to pay an annuity to B or other annuitant in fixed amounts over the life of the annuity, with the beginning date for payment deferred to some date in the future.

The annuity contract allows the annuitant to elect the commencement date of the payments under the annuity at any time after the annuitant, who is currently age 50, reaches age 55. When the election is made by the annuitant, the annual annuity payment will be determined based on the age of the annuitant in accordance with pre-existing tables . . .

Accordingly, we rule as follows:

The issuance of a deferred charitable gift annuity, as described above, will not result in income from an unrelated trade or business as defined in section 511-513 of the Code.

The income earned by the Foundation from investment of charitable gift annuity funds will not be unrelated debt-financed income within the meaning of section 514 of the Code.

The annuity contract issued by the Foundation, as described above, is a charitable gift annuity within the meaning of section 501(m)(5) of the Code, as long as the value of the annuity is less than 90% of the property received by the Foundation.

IMPORTANT Suggestion: When the Annuity is established, print out and keep in the file future payment schedules for the optional

I’m Just Asking:

Since the PLR request did not stipulate a mandatory annuity payment starting date (i.e., no later than), and the PLR was issued as requested (as described above), why include a “no later than” provision in the contract? The charitable deduction is based on the earliest possible starting date. Further if a named beneficiary of a traditional deferred gift annuity dies before payments begin, the DGA terminates and is distributed to charity.

7. CGA for “Domestic Helper” is NOT a Gift!

A gift annuity funded by a donor to benefit a faithful employee is considered compensation rather than a gift.

The entire amount used to fund the CGA is deductible to the ER: The Gift Portion as a charitable gift and the present value of the future annuity payments as wages (subject to normal withholding).

ER’s Problem – (1) Withholding. (2) If funded with appreciated securities, the capital gain attributable to the future payments is recognized by

the ER in the year the CGA is funded.

EE’s Problem - The present value of the future annuity payments must be recognized by the EE in the year the CGA is funded, leaving the EE

with a substantial tax bill. (The EE’s annual payment will be taxed like a traditional annuity payment.)

Solutions: (1) Bonus income to the EE to pay the tax. (2) Retain the right to revoke. The ER is still entitled to a charitable deduction for the gift

portion. Each annuity payment is then deductible by the ER wages (subject to normal withholding) and fully taxable to the EE as paid/received.

Independent Contractor If the Domestic Helper is an independent contractor, he or she is responsible for their own withholding.

(You may refer to Charitable Gift Annuities, The Complete Resource Manual by Frank Minton (chapter 15, pgs. 2-3 and Chapter 20, pgs. 32-33) for more details.)

8. FLEX DGA – Donor Retains the Right to Turn on the Payments for NON-Donor Beneficiary

9. FLEX DGA – Can You Insert a Flip Provision in a Flexible Gift Annuity?