ExampleA wonderful feature of a gift annuity is that beside the fixed payout, the agreement provides the donor with additional benefits in the form of a charitable deduction and partially tax-free payouts. With a CD or other investment, the donor would not receive an income tax deduction or partly tax-free income each year. The double tax savings – income tax savings from the charitable deduction in the year of the gift and the additional tax savings from the tax-favored CGA payments – are likened to receiving a higher rate of return. Due to the fact that these payout rates are not interest rates, but rather payouts that will diminish the gift principal, this is an inexact comparison. However, if the donor desires to benefit charity and secure a fixed payout stream, a CGA is a great option to discuss with a trusted financial advisor.
John is a loyal donor at his favorite local charity. He is a conservative investor and has $100,000 invested in CDs. He receives 2% income from these investments. John takes $35,000 of cash that was formerly in a CD, and instead of reinvesting in another CD, he establishes a charitable gift annuity. John has made an irrevocable gift to charity. Unlike investing in CDs, the funding value of the CGA will not return to him in a lump sum at an appointed time. He continues to invest $65,000 in CDs. The CDs produce 2% interest income per year, generating about $1,300. John’s $35,000 gift annuity pays out at a rate of 7.4%, generating a payout stream of $2,590 per year for the remainder of his life. Additionally, John will receive a $16,658 tax deduction. His income tax rate is 24%, so his estimated tax savings in the year of the gift are $3,997. Compared to the return rate for a CD, the “effective rate” of a gift annuity is actually higher than the 7.4% payout rate. The gift annuity payout for John is $2,590 per year. However, when one considers the benefits of John’s tax savings, it is similar to receiving $3,997 or an 11.4% payout in the first year from other taxable investments.
ExampleThis “bunching” concept applies to establishing gift annuities as well. Donors could potentially increase their giving in one year to establish a CGA. The donor would receive a deduction in Year 1 based on itemizing deductions, and in Year 2 could simply take the standard deduction. Meanwhile, the donor will also have helped a charity and created a fixed payout stream for life.
Let us look at two couples, John and Mary Jones and Harry and Susan Green. Both pay $8,000 in state and local taxes and $7,000 in home mortgage interest. They each give $8,000 to their favorite charity each year. The total itemized deductions for each couple are $23,000 per year.
Because the standard deduction is larger than their $23,000 in itemized deductions, John and Mary claim the $24,400 standard deduction in 2019 and the $24,800 amount in 2020. Their total deductions over the two years are $49,200.
Meanwhile, Harry and Susan decide to “bunch” their charitable deductions. They give $16,000 in 2019 and nothing in 2020. Because their total 2019 itemized deductions with the increased charitable deduction now reaches $31,000, the standard deduction is exceeded. Harry and Susan elect to itemize their 2019 tax deductions. In 2020, they take the standard deduction of $24,800. Their total claimed deductions are $55,800.
By “bunching” their deductions, Harry and Susan increase their tax savings from their charitable gifts. The $6,600 increased deductions may save $1,848 in their 28% combined federal and state income tax brackets.
Joseph and Judy, age 83, are both retired. They typically make generous gifts to charity of $18,000 each year and include it with their income tax deductions. The couple would like an income tax deduction this year and would also like to supplement their annual income, but since the TCJA doubled the standard deduction, their $18,000 gift, along with their other deductible expenses, does not exceed the standard deduction. They ask their tax advisor if there is any way they can take a deduction this year while also increasing their annual income. The couple’s advisor explains that they may wish to “bunch” their charitable gifts. He also notes that Joseph and Judy may wish to look into a charitable gift annuity. With a $45,000 funding amount, the couple will get a deduction of $20,295 this year. This deduction may save $4,870 in income tax. They will itemize their charitable deduction along with their other deductible expenses. At the current 2020 ACGA suggested maximum rate of 6.4%, Joseph and Judy will receive a $2,880 payout each year for their lifetimes.