CHARITABLE GIFT ANNUITY or CHARITABLE REMAINDER TRUST
Helping the client to decide
Clients in or approaching retirement years will often enter their advisor’s office with brochures in hand from favorite charities touting the benefits of charitable gifts that pay lifetime income. The two most common gifts are the charitable gift annuity and the charitable remainder trust. A comparison of these two gift vehicles can be helpful in advising the client.
How the gifts work
- A charitable gift annuity (CGA) is a contract between the charity and the donor in which the charity, in exchange for the donor’s gift, agrees to pay up to two annuitants a fixed amount of income for the rest of their lives. A deferred gift annuity (DGA) allows the donor to make the gift now and receive a charitable deduction, but defer payments into the future.
- A charitable remainder trust (CRT) is a separate tax-exempt irrevocable trust into which the donor contributes cash, appreciated securities, or illiquid assets such as collectibles, real estate, and possibly a business interest. A CRT is the umbrella term for various types of charitable remainder trusts which differ by how their distributions are calculated to the income beneficiaries. A charitable remainder trust can pay a variable amount based on the value of the trust assets (a charitable remainder unitrust or CRUT) or a fixed annuity amount (a charitable remainder annuity trust or CRAT). A CRT can be for the life of the income beneficiaries but can also be for a term of years not to exceed 20 years.
Comparison of CRTs and CGAs
- CGAs are appealing to donors because of the fixed income payments not subject to financial market fluctuations, attractive annuity rates, partial tax-free income, and an income tax charitable deduction. CGAs are simple for donors to understand. DGAs, where income payments are deferred into the future, can serve as excellent retirement planning vehicles for high-income clients. DGA contracts can be written to give the donor flexibility in choosing when to turn on the income stream. All gift annuities are backed by the assets of the charity. The minimum amount to establish a charitable gift annuity with the Red Cross is $5,000.
- CRTs are flexible to meet the donor’s financial and charitable objectives. A CRT is not limited to two income beneficiaries. A CRT is better suited to accept and liquidate an illiquid asset (i.e., real estate, business interests), while also working well when funding with appreciated securities. CRUTs have the potential for income distributions to increase over time, and hopefully serve as an inflation hedge, unlike the CGA and CRAT where the income is fixed for life. Also, CRUTs can receive additional contributions, generating a new tax deduction, at any time. Generally, CRTs usually are utilized when the gift is over $100,000.
- CGA payments are fixed for life, with no inflation protection. Only two annuitants are permitted on a CGA contract. It is difficult for a charity issuing CGAs to accept an illiquid asset to fund a CGA.
- CRTs are more complicated and expensive to establish and administer than CGAs. CRTs require investment management, somewhat complex tax reporting, and annual tax filings with the IRS. While a CRT is better suited to accept illiquid or complex assets, that also requires trustees and advisors with expertise in such matters. CRAT payments are backed solely by the trust, so they could cease if the trust ran dry. The Red Cross has the expertise to serve as trustee and handle all the necessary duties.
- CGA - The payout is based on the age of the annuitant, in accordance with the Association of Charitable Gift Annuities (ACGA) recommended rate schedule. The older the annuitant(s) is at funding, the higher the annuity rate. With a DGA, where payments are deferred into the future, the annuitant(s) will receive a higher annuity rate depending on the length of the deferral period. ACGA rates can be accessed at https://acga-web.org/gift-annuity-rates or contact the Red Cross anytime for a specific illustration for your client.
- CRT – The donor can select the pay-out rate in the CRT agreement, subject to the IRS requirement that the rate cannot be less than 5% or greater than 50% (other IRS probability restrictions must be met too). If the Red Cross is the trustee, most payout rates are between 5%-6% for lifetime beneficiaries. A payout rate that is too high risks the income payments’ buying power being eroded and trust assets being exhausted, thereby resulting in very small or an end of payments to the income beneficiaries.
Taxation of Payments
- CGA annuity payments are taxed partially as ordinary income and partially tax-free income. The tax-free income is a return of principal divided by the annuitant(s) life expectancy measured from the date the gift was established. If the annuitant(s) outlive their projected life expectancy the entire payment is taxed as ordinary income. If the CGA is funded with long-term appreciated securities some of the capital gain will be immediately forgiven with the remaining gain reported pro-rata as capital gain income. As with the tax-free portion, the capital gain is spread out over the annuitant(s) life expectancy at the time of the gift.
- CRT payments are taxed on a Worst in/First Out (WIFO) basis. The tax character of the assets used to fund the trust and investment activity within the trust will determine how the trust distributions to income beneficiaries will be taxed. The CRT payments are generally divided in four tiers with the most heavily taxed assets distributed first. Roughly speaking: (1) Ordinary income earned by the CRT is distributed first; (2) Capital gain income (including pre-contribution capital gain); (3) Tax-free income; and (4) Return of principal. There are sub-categories within the four tiers that further detail the taxation of trust distributions.
Many donors find life income gifts to be a great way to support favorite charities. However, each life income gift vehicle has advantages and disadvantages and clients often look to their advisors to offer guidance when establishing such a gift. Advisors are encouraged to consult with the Red Cross Gift Planning office. Our gift officers would be happy to answer questions and assist in evaluating which gift vehicle best serves your clients’ objectives.