Deferred Gifts with Income Benefits

Category: Endowment Building

Donors may make irrevocable gifts during their lifetimes in which they (or their chosen non-charitable beneficiaries) retain benefits during their lifetimes (or for a period of years) and the organization(s) receive the remaining assets. These gifts are sometimes called “split interest” gifts, because the donors and the organizations each have financial interests in the assets.

  • Charitable gift annuity. A charitable gift annuity is a contract under which a charitable organization, in exchange for cash or other property, agrees to pay a fixed sum of money for a period measured by one or two lives. The person who contributes the asset for the annuity is called the “donor,” and the person who receives the fixed payments is called the “annuitant.” Usually, the donor and the annuitant are the same person, but this is not always true. A donor can make the contribution and direct the payments to her- or himself. Alternatively, the donor could direct that the payments be made to someone else (e.g., a sibling or parent). The maximum number of annuitants is two, and payments can be made to them jointly or successively.

Gift annuity payments can begin immediately after the contribution or begin on a future date, which is called a deferred-payment gift annuity. The longer the annuitant waits to start payments, the larger they will be. Whether a gift annuity is immediate or deferred, payments are fixed from the outset. They will neither increase nor decrease, no matter what happens to interest rates or the stock market. The organization is contractually obligated to make the payments, even if it has to dip into its general funds to do so. Fixed payments are a source of comfort to people who don’t want their future security to be dependent on the performance of financial markets. The disadvantage of fixed payments is that they offer no inflation protection.

Small and midsized organizations may not want to offer gift annuities on their own, but rather partner with a larger institution such as a national affiliation or a community foundation.

Gift annuity rates are determined by the age of the person or persons who receive the income payments. The older the beneficiary, the higher the gift annuity rate. Although the exact rate may be negotiated, most nonprofits follow the rate provided by the American Council on Gift Annuities (www.acga-web.org).

Benefits to the donor include the following:

  • Income for life is at payout rates established for one or two lives.
  • A part of the gift is a current, deductible charitable gift.
  • A large portion of the annual payout is tax-free return of principal.
  • Capital gains tax savings are realized when appreciated assets are used for the gift.
  • Estate taxes are avoided on the gifted asset.
  • Personal satisfaction is obtained from making a gift of lasting significance.

Charitable remainder trust. Charitable remainder trusts also offer income to the donor or other beneficiaries designated by the donor and are more complex to establish than a charitable gift annuity. There are two basic types, with numerous sophisticated variations possible.

  1. Charitable remainder unitrust. With a charitable remainder unitrust, the donor irrevocably transfers money, securities, or other property to a trustee. Usually, the nonprofit organization does not serve as a trustee of a charitable remainder unitrust; that role belongs to a bank trust department or a brokerage firm selected by the donor—or the donor may be the trustee him- or herself. The trustee pays the donor (or one or more income beneficiaries designated by the donor) a fixed percentage of the net fair-market value of the trust’s assets, as determined each year. The payments are made for the life or lives of the income beneficiaries or for a fixed period of years not to exceed 20 years. Upon termination of the income beneficiary’s interest, the assets of the unitrust are transferred to the nonprofit organization.
  2. Charitable remainder annuity trust. A charitable remainder annuity trust works like a unitrust except that the income beneficiary receives a fixed dollar amount annually from the trust. The amount distributed to the beneficiaries does not change as the value of the trust increases or decreases. The annuity trust is particularly attractive to people who want certainty about the amount of the annual payments.

By establishing a charitable remainder trust, the donor can accomplish the following:

  • Establish an income for life—one that can grow, or shrink, over time (a unitrust) or one that will remain constant (an annuity trust).
  • Reinvest a highly appreciated low-yield asset, without incurring capital gain tax.
  • Reduce income taxes.
  • Gain the investment and administrative services of a trustee.
  • Get rid of the financial and personal burdens of managing the asset, especially in the case of real estate.
  • Remove the asset from his or her estate.
  • Make a magnificent gift to the organization’s endowment fund.

Unlike charitable gift annuities, the assets of a charitable remainder trust may be exhausted and payments may cease.

Pooled income fund. A pooled income fund accepts gifts from many donors, “pools” those funds together for investment purposes, and distributes the fund’s earned income on a proportional basis to all participants or beneficiaries designated by the donors. When the named income beneficiary passes away, the portion of the fund’s principal associated with the gift is added the organization’s endowment fund.

Small and midsized organizations may not want to start their own pooled income fund, but rather partner with a larger institution such as a national affiliation or a community foundation. During times of generally low interest rates, many organizations do not offer pooled income funds.

Donors to the pool receive charitable income tax deductions based on their ages at the time the gifts are made. The amount of the annual payout fluctuates with the value of the fund, so the donor may also gain a practical hedge against inflation. The gift may also produce estate tax savings, especially if the income beneficiaries are the donor and the donor’s spouse.

Future interest (or retained life interest) in real estate. A donor may make a gift of a personal residence or farm to the organization and retain the right to occupy the property until death. Upon the donor’s death, the organization will own the entire interest in the property. The donor will receive an income tax deduction for the present value of the gift. The donor should obtain an independent appraisal of the value of the property and should commit, in writing, to pay the taxes, insurance, and upkeep on the property until the transfer of the property to the organization. These gifts should be evaluated by the organization’s board of trustees and its counsel on a case-by-case basis.

The Donors’ Desires Are Paramount

Whatever gift vehicles donors choose, donors make gifts in their time frame, not necessarily the organization’s. The gift reflects the donor’s interests and values, not necessarily the priorities of the organization. Be careful, however, that the organization does not stray from its mission in attempting to meet the donors’ objectives. For example, a donor who wants to endow a new program at the zoo for rescued birds of prey could be redirected to the local veterinarian school or wildlife rescue operation—unless the zoo is already planning to establish such a program.

Fundraising professionals who are most successful at attracting gifts for their organizations generally are able to focus their donor cultivation and solicitation programs around understanding the donor’s concerns and passions, building a firm relationship with the donor, and linking the donor’s urgent considerations with the organization’s salient advantages, purposes, and programs.

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