A charitable gift annuity is simply an agreement in which a charity agrees to pay an income to a donor for life or for a set period of time in exchange for a lump sum. The lump sum could be in cash, securities or any other instrument of value. The usual arrangement is that the charity will provide a stream of fixed, level payments on a monthly or annual basis until the donor dies. The charity then keeps any unpaid annuity balance.
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Reasons a Charity Would Enter a Gift Annuity Contract
The charity has a number of incentives to enter into charitable annuity arrangements: The charity can benefit from the immediate receipt of a lump sum of money, which they can put to work immediately, though they must maintain enough reserves to pay income benefits to donors. The charity also benefits if the donor passes away before the funds are exhausted. Charitable annuity sponsors use actuarial tables to calculate payout rates that are reasonable and sustainable based on actual mortality statistics. There is, however, a risk that donors could outlive expectations, and the charity could potentially pay out more in benefits than it takes in in revenues from donations and interest on investments.
Reasons a Donor Would Enter a Charitable Annuity
A donor may wish to have an assurance of an income
for life, with little desire to pass the assets on to heirs. By purchasing a charitable annuity from an organization on sound financial footing, the donor gains the security of a guaranteed income, the satisfaction of assisting a worthy cause and the benefit of moving assets out of his estate, where they may be subject to the estate tax.
Types of Charitable Annuities
There are three broad categories of charitable annuity payout arrangements: The "single life" arrangement, which pays income to a single individual for life; the "two lives in succession" contract, which pays a designated survivor, if any, for life, if the primary annuitant dies first, and the "joint and survivor" contract, which splits the annuity income between two individuals until one dies. At that point, the charity pays the full annuity income to the survivor for life. Single life arrangements pay the highest income.
The IRS considers part of the donor's income from a charitable annuity to be a tax-free return of the donor's gift. The donor is only taxed on the portion of the annuity that represents growth, according to a formula called the "exclusion ratio." The exclusion ratio is equal to the total donation divided by the expected benefits based on the donor's life expectancy. The result is the percentage of the annuity's payout that is excluded from federal income tax.