Balancing income with spending needs during retirement is a tough nut to crack even for the most careful planners. To that end, annuities have begun to get the nod from the financial planning community, regulatory and individual investors. But not all annuities are the same. There are some which make more sense to investors now than ever before.
We are talking about charitable gift annuities.
Thanks to a variety of factors, charitable gift annuities have been “left for dead” by investors over the last decade or so. However, recent turns of events have made the annuity variety very lucrative for a variety of situations. It is time that we start considering the humble gift annuity again.
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What Is a Gift Annuity?
Annuities are essentially contracts between an investor and an insurance company, in which for the exchange of a lump sum investment, the insurance firm promises to pay a certain amount for a set amount of time. The scheme takes on many forms, with various interest crediting, term lengths and other provisions. Charitable gift annuities function in much the same way.
Here, a donor hands a charity an initial investment and then receives a stream of payments for a set term. The ins and outs require the charity to take half of the gift for its efforts and invest the other half in its general fund to make the annuity payments. When a donor passes on, the charity gets to keep the remainder and any gains it earned. This set up is often why charitable gift annuities are called “split gifts.”
This splitting is why gift annuities can be appealing to investors. Because the charity is able to use half of the gift right away, investors can claim tax benefits from the donation. Those taxpayers who itemize deductions can claim a charitable income tax deduction for a portion of the original gift. This amount is equal to the contribution minus the present value of the payments made to the donor during life. Using IRS tables regarding life expectancy and assumed earnings, charities determine this amount. For example (using current rates), a 60-year-old individual donating $10,000 to a charitable gift annuity would be able to deduct $3,870 from their taxes.
Back In Favor
Despite the good deal of tax deductions and income for life, gift annuities have not been very popular in years. And there are two major reasons why. For one, interest rates have been essentially zero since the Great Recession. With inflation running low over the last decade and economic growth being stagnant, the Fed left benchmark rates languishing. And with that, payouts for annuities have been less than ideal.
Secondly, the tax picture has been low as well. The Republican tax cuts of 2017 and the near-doubling of the standard deduction has reduced the appeal of charitable donations or at least the tax aspects of them. For many, individuals taking the standard deduction has been the easier route than itemizing.
Both of these factors suppressed interest in gift annuities for other vehicles. However, times may be changing.
For one thing, interest rates have started to surge and have continued to grow. This has pushed yields on the 10-year higher. And in that, so have annuity rates. According to the American Council on Gift Annuities, a 60-year-old can now lock in a 4.5% payout rate – up from 3.75% a year ago. That amount jumps to over 5% for someone at full retirement age of 67 and nearly 8.1% for someone in their 80s.
Secondly, the tax picture has gotten murkier. With a new president and the potential for higher taxes down the road, many investors are now looking to lock in capital gains at lower tax rates. Like many donations, a charitable gift annuity allows donors to give appreciated stock or assets to skirt capital gains taxes. Meanwhile, depending on how the gift was initially made – cash, stock, real estate – the income portion of the gift annuity may also be tax advantaged as well. Allowing investors to plan future tax plans during retirement.
The shift in rates and tax policy has once again made gift annuities a powerful choice for investors to consider.
Don’t forget to check out this article to learn how the SECURE Act can impact annuities.
How To Add a Gift Annuity to Your Portfolio
Purchasing a gift annuity is a straightforward process. Most large charities offer them as well as many universities and similar organizations. A simple phone call or email to the giving office of the charity is sometimes all you need.
However, there are some things to keep in mind. Annuity payments are driven by the ability of an insurance company to remain solvent. The same goes for charities. If a charity goes bankrupt or dries up, so do your income payments. So, it pays to focus on larger and financially sound institutions. There is a slim chance that a major state university or an organization like the Nature Conservancy disappears. That cannot be said for a local community foundation. Go big and financially sound in this case.
Secondly, payments are fixed and you can’t get your money back. Unlike a regular annuity that can come with payments tied to inflation or exit clauses, gift annuities are typically one & done. You make the donation; this is what you get. Investors worried about inflation can always layer gift annuities over a few years to lock in higher payout amounts.
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The Bottom Line
Thanks to changes in interest rates and the tax picture, charitable gift annuities make a lot of sense these days for investors. The ability to get income for life as well as some hefty deductions have breathed new life into the investment.
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