How insurance professionals can help charities and their donorsArticle added by Ken Davis, Retired CPA, CLU, ChFC on August 23, 2012
Ken Davis

Ken Davis, Retired CPA, CLU, ChFC

Scottsdale, AZ

Joined: November 23, 2009

My mission in writing this article was to help provide much needed income to our seniors while raising substantial donations for charities.

The current low interest rate environment has a silver lining. Since immediate annuity distribution rates are driven more by a person’s age than by interest rate, they become a very attractive vehicle for people in their 70s and 80s looking for income.

Further, because most of the cash flow is not included in taxable income, the income tax results may improve dramatically, further enhancing after tax cash flow for the retiree. So, this may be the perfect time to raise funds for charities using charitable gift annuities (CGA), and alternative concepts, while helping struggling retirees produce more cash for them to live on.

This article will suggest ways to enhance the typical CGA experience to both the charity and the donor through the use of commercial immediate and deferred annuities instead of, or in addition to, the typical CGA structure. In some cases, life insurance may be useful as well.

Charitable gift annuities (CGAs) are financial arrangements whereby a donor gives a lump sum gift to charity in exchange for a lifetime income. The charity provides an income to the donor substantially lower than a commercial annuity would for the same age; that is why it is considered charitable in nature. The charity will be paying the donor principal plus interest for their lifetime. The calculation for this distribution is designed so that only about half the donation is used up at the estimate time of death.

For example, a widow age 75 has $300,000 sitting in bank CDs in addition to other assets and retirement income. She is making 0.5 percent per year on her money, and the interest is fully taxable. The charitable gift annuity rate suggested payout for a 75 year old is currently about 5.8 percent. That means if she chooses to gift $100,000 of her bank CDs to a charity in exchange for a CGA, she would make $5,800 in distributions on the CGA compared with only $500 on the $100,000 bank CD. The distribution is mostly a return of tax basis and therefore mostly income tax free.

Additionally, she gets an income tax deduction for the charitable element of the CGA. This is an actuarially-computed present value calculation on the gift portion of the annuity based on IRS guidelines.

Through the use of a CGA, the donor gets to improve his or her after-tax cash flow knowing that the unused portion of their gift will be left to the charity at death. And they get a partial tax deduction.
You may want to go to the the Arizona Community Foundation website, which calculates the income, the tax deduction and the tax free income portion at various ages and tax rates for a CGA, to get an idea of how this works for various ages and amounts. You can play on their calculator here. Many other charities have similar calculators on their websites. The website creates the calculations and a slide show, making it easy for donors to privately calculate how their donation might work for them.

In the prior example, the insurance professional may also suggest that the donor move an appropriate amount of the remaining bank CDs to some fixed deferred annuities. The $100,000 CGA more than replaces the $1,500 in interest income on the $300,000 of bank CDs with $5,800 in CGA distributions.

The remaining reallocated money may be put into deferred annuities for growth or even a commercial single premium immediate annuity for additional income. Or they may purchase a life policy to provide tax free death benefit to the kids as a legacy and to replace the gift. Or they may even use it to build a cash value policy with cash accumulation and leave the charity or kids as a beneficiary. Use your imagination to provide and appropriate solution for the client.

We mentioned earlier that the distributions are calculated based on average life expectancies. We all know that those averages only work on large numbers of policies. The mix of ages and gender impacts these calculations, as well. And interestingly, some have suggested that wealthy donors tend to live longer than the average person because of their access to better health care and lifestyle options. And who knows what other demographic details may further influence the mortality rate of donors?

Of these items, age is one of the trickiest. Younger people pose a much higher potential risk to those trying to manage CGA payouts and the gifted assets supporting them. The fact is that medical science continues to lengthen our lives and more and more people are watching what they eat and how they exercise. All of this could cause the charity to pay more out than they should.

The charity is, in essence, acting as a life insurance company. In many cases, their CGA portfolios are not large and diverse enough to protect them from the actuarial risk of a poorly designed CGA portfolio. Further, for the charity to succeed, they also have to have good asset management and of course there is considerable market and interest rate risk in today’s markets.
All of the above suggests that the charity might want to stay out of the business of insuring CGAs and managing money; in that case, there are ways for them to benefit from CGA gifts by offloading the risk to a stronger and more sophisticated institutions. Here are two alternatives to consider.

The charity could run their CGA gifts through a community foundation. The community foundations may be much more financially sound. They may hold a larger, more diverse portfolio of CGAs and may have a more sophisticated money management apparatus in place. Or, they may have other strategies to hedge the risks of holding the CGAs. They typically charge a management fee and pay an annual endowment at death to the charity that brought the gift to them for management. The endowment may be somewhere in the range of 5 percent.

Another alternative is to bring a large, highly-rated life insurance company to the table to take the risk off their hands. A simple strategy would be to have the donor buy a commercial immediate annuity that produces an amount equal to what the charity would have paid them. Because the distribution is below market there will be an excess amount they can then donate to the charity as cash.

For example, a woman age 75 wants to donate a $100,000 to a charity as a CGA. The agent shops the market and finds one that pays $5,800 per year on a premium of $80,000; this is equal to the recommended CGA distribution rate I found for a 75-year-old woman. The donor would buy the annuity and then donate $20,000 to the charity. She gets a $20,000 tax deduction, the immediate annuity distributions are mostly tax free until tax basis is used up. She gets a lifetime guaranteed income from a highly rated life insurance carrier or carriers that she chooses. The charity gets the $20,000 in cash. The donor can specify the gift as a current gift or to be placed in an endowment account with the charity. The donor may have a more sound financial institution guaranteeing the income and the charity avoids the risk of money management and mortality assumptions. It ay be a win-win for everyone involved, including the insurance agent.

Many charities are too small to hire people to raise money for the charity. Insurance agents appropriately educated on these concepts could act as a non-salaried alternative to salaried development officers for the charity. They could help the charity promote planned giving strategies with their board members, officers, staff, volunteers and members. They could offer to meet with those donors that express an interest in giving to the charity. The insurance professional gets paid on the annuity strategies supporting the gift to the charity.
Of course, the insurance professional must be concerned with the downsides of immediate annuities, such as lack of liquidity and inflation concerns, when determining if a CGA or CGA alternative is appropriate for the donors. It would be wise to include the client’s CPA or other knowledgeable close relatives or friends in the discussion for the protection of both the client and the agent in evaluating this concept.

It would give me great joy to see a large number of my insurance professional colleagues go out and generate some major gifts for charities. And, the dramatic increase in income that retirees could benefit from by using immediate annuities, even at reduced rates, could greatly enhance their lives. It may even give them enough additional income to afford additional current gifts to the charity.

And finally, the additional income could also be used to purchase life insurance policies that may replace part or all of what is left to charity for the kids. And where that is not necessary, the donor could use some of the additional income from the CGA or CGA alternative to leave a life policy to the charity as an endowment at their death.

So to recap, the CGA and alternatives are as follows:
  • Traditional CGAs with the charity managing their own program
  • Traditional CGAs managed by community foundations
  • The combination of a commercial annuity and cash gift
  • The combination of a commercial annuity, cash gift and life insurance left to the donor’s heirs or charity of their choice
Please consider using the CGA or CGA alternative to help charities raise much-needed donations and to help our elderly, where appropriate. And of course make sure you consider the liquidity needs and inflation needs of the client. Being fair and compliant is critical in serving our seniors.

I am not an actuary or attorney and do not offer any legal or actuarial advice through this article. Further, while I am a CPA I do not actively practice as one and I do not offer any tax advice either. Readers of this article are therefore advised to seek competent legal, actuarial and tax advice from qualified professionals.
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