A gift annuity's advantages include doing a good deed for worthy cause

The Savings Game

Your Money

July 03, 2005|By Humberto Cruz

Q. My husband is interested in giving a gift annuity to his alma mater. I do not know or understand the ramifications of this, or whether it is a good thing to do.

A. With a gift annuity, you make a lump-sum donation to a charity (for example, a hospital or school) and in return receive an income for life.

Most people become aware of gift annuities through newspaper ads pitching what seem like high interest rates that magically go up with age, such as 5.7 percent at age 60 and 8 percent at age 80.

I have occasionally come down on these ads because some use the term "interest rates" or "yield" to describe payout rates that are only part interest (the rest, often the bulk of each payment you receive, is the return of your own principal).

That nitpick aside, gift annuities can be an attractive option for charitably inclined older Americans looking for a lifetime income stream.

In one way, gift annuities are similar to the immediate annuities promoted by insurance companies. In return for a lump-sum amount, you receive an income for life.

With a gift annuity, the payments you receive are lower for the same lump sum. They must be, because the charity expects to keep some of your money when you die.

In return, the donor gets a tax deduction (based not on the lump sum you put up but on what the charity can expect to keep after making lifetime payments to you), plus the satisfaction of helping others. Gift annuities also typically offer higher lifetime after-tax income than is available from bank certificates of deposit or other high-quality fixed-income investments.

"For people who need to rely on a fixed income, often the biggest concern is running out of money," said Chase Adams, an attorney and planned-giving consultant in Fort Lauderdale, Fla. With a gift annuity, "you cannot outlive your money, no matter how long you live."

Most charities that offer gift annuities base their payouts on rates suggested by the American Council on Gift Annuities (www.acga-web.org). For example, the payout rate for a husband and wife, both age 70, is 5.9 percent now. If they put $100,000 into a gift annuity, they would receive $5,900 a year until both died.

The same $100,000 in a regular immediate annuity would produce payments ranging between $6,900 and $7,300 a year, based on quotes from several insurance companies.

But with the gift annuity, in one example provided by Adams, this 70-year-old couple would be entitled to a tax deduction of $33,800.82. This tax deduction could be spread out over as many as six years and is not lost later if the donors live longer than expected, in effect reducing the money the charity makes in the transaction.

In this example of the $5,900 the couple would receive each year for life, about $3,292 would be considered a return of principal and therefore not taxable for the first 20.1 years (that's 20 years plus a little more than a month), which is the couple's combined life expectancy. After that, the entire $5,900 would be taxable.

In a regular immediate annuity, since there is no gift to a charity, a bigger percentage of each payment is considered to be a tax-free return of principal.

If and when the annuity purchaser reaches life expectancy, all principal will have been paid back. Any subsequent payments would all be taxed as ordinary income.

For a charity to be able to issue its own gift annuity, it must register with each state where it wants to solicit, and it must pledge all the charity's assets to guarantee payments. But you may be able to contribute to a charity that does not issue its own gift annuity by going through a third party.

For example, Adams' firm, Adams and Associates, works with several charities that have not qualified to issue gift annuities. In those cases, his firm uses a proprietary charitable "Lifetime Income Program" that gives the donor a similar income.

In the example of a $100,000 deposit, $82,806.08, which is the actual amount needed, would be used to fund a regular immediate annuity with an insurance company that pays $5,900 a year for life.

The charity would receive the remaining $17,193.92 right away, and the donors could claim a tax deduction for that amount.

Humberto Cruz is a columnist for Tribune Media Services. E-mail him at yourmoney@tribune.com.

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