The caller was calm but clearly concerned. She wanted to know if a particular charitable gift annuity (CGA), written twenty-something years ago, had been calculated correctly. And she also wanted to know if there was anything that the sponsoring charity could do now “to get out of it.”
She had piqued our interest. We see a lot of good charitable gift annuities that have been written over the years, but we’ve also seen some highly questionable examples. A charitable gift annuity is a split-interest gift, an arrangement between the sponsoring charity and the donor. The donor makes a significant contribution to the charity – typically at least $10,000, and frequently much more – and the charity agrees to make payments to one or two persons for the rest of their lives.
The inherent presumption is that there will be some portion of the gift left when the final annuitant passes. That portion is referred to as the “residuum” or the “charitable remainder.” The donor gets a tax deduction up front for a portion of the original gift amount; that number is an official estimated value of the eventual benefit for the charity. Planned giving officers and allied professionals generally expect at least 50% of the original funding amount to be left at the end of the gift annuity experience.
In this case, the gift annuity was established in 1998. It was funded by $200,000 of marketable securities, held for many years by the donor, with a cost basis of $83,081.47. The donor was 92 years old at the time, but he wanted his granddaughter to be named as the second annuitant. The granddaughter was 36 years old at that time. Stop. Wait. What?? The granddaughter was named as the second annuitant, and she was 36 years old at the time the gift annuity was established.
Before we go any further, let us all remember, it is always easier to recognize mistakes in the rearview. Hindsight, as they say, is 20/20. These days, there is pretty much unanimous consensus that a good gift acceptance policy would specify the minimum age for receiving gift annuity payments. Minimum age policies were fairly popular even back in the 1990s, but the policy was not always applied consistently to second annuitants. At that time, many organizations chose to be silent on the minimum age for second annuitants. As long as the primary annuitant was above a particular age, there was little or no concern about the age of the second annuitant.
The planned giving officer who was questioning the accuracy of the gift annuity now was not working at the charity in 1998. In fact, she was probably still in school at the time – 27 years is a long time! Unfortunately, we had to explain that the calculations for this gift annuity were, in fact, done correctly. The grandfather had gotten a charitable deduction of $35,392. The annuity rate was 5.7%, which was relatively low at the time. The payout rate clearly recognized the very long combined life expectancy of the donor and his granddaughter.
The annuity was $11,400 and was to be paid in semi-annual installments. Since the charitable deduction was $35,392, the investment in contract – the value of the annuity itself – was $164,608. This brings up an important point that we should make – the charitable deduction and the investment in contract / value of annuity add up to the total funding amount. The minimum charitable deduction – for the gift to be recognized as a qualified charity gift annuity – is 10% of the funding amount. If the minimum amount for the deduction is 10% of the funding amount, that means the investment in contract / value of the annuity can be up to 90% of the funding amount.
The federal government requires a charitable deduction of at least 10% of the funding amount, but is that really good enough for the charity? That means, for a split-interest gift like a CGA, the personal benefit can be up to 9 times the amount of the benefit to the charity. Just because it’s permissible doesn’t mean it’s a GOOD gift. We work with a number of organizations who require at least a 20% charitable deduction.
For this organization, the future looked bleak, even at the outset. The investment in contract was $164,608, as mentioned above, but the “expected return” was $527,820. The expected return is an estimate of how much would actually be paid were the annuitants to die “exactly on schedule” – that is, to die precisely at the points suggested by the relevant mortality tables. In this case, the combined lifespan of the two annuitants was 46.2 years! The charity was poised to pay $11,400 a year to the donor and then to the granddaughter for over 46 years. And that was just according to average life expectancy at the time.
We all know that most gift annuities run longer than originally projected, because most annuitants live well beyond their originally projected lifetimes. The planned giving officer was frustrated because her organization had already paid well over $300,000 to the donor and his granddaughter, and likely they would continue making payments for many years to come. We had to be the bearer of bad news and explain that they likely would have to pay another $200,000 or even $300,000 to the granddaughter, due to her living far beyond the originally projected lifetime.
There was no way around the fact that the charity was truly obligated to continue paying $11,400 per year for as long as the granddaughter lives. The only alternative would be to convince her to irrevocably relinquish her remaining life interest in the gift annuity. That action would be in exchange for a charitable tax deduction or for a cash payout. It appears unlikely that the granddaughter would simply give up her annuity, especially since she has no direct connection to the charity. Were the charity to agree on a cash settlement instead, it would almost certainly be a significant amount of money.
So, is this the worst gift annuity ever written? Certainly not! We actually meant the question in the rhetorical sense. This gift annuity was written with the best of intentions and it followed the recommended (and appropriate) payout rate for the two lives involved. We’ve seen much worse gift annuities written over the years – some involving questionable real estate holdings, others involving tangible personal property, and too many instances of inflated payout rates due to rate-shopping – to name a few of the most common offenses.
The bottom line here is that the gift annuity was calculated correctly in 1998. We can question the decision to write the gift annuity, but the ink is long dry on this contract. The charity has paid huge amounts already to the donor and the granddaughter, and is on the hook for paying out a lot more money over the life of the granddaughter. It’s likely that the only way out for the charity is to fork over a very large amount of money to end the misery now.
The charity will have to evaluate the costs and benefits of each alternative, then decide on which one is less painful. There is no easy solution. This will have to serve as a reminder in the future, to help guide decisions about when to write a gift annuity and when NOT to write a gift annuity.