Philanthropy is top-of-mind for many of our clients during the holiday season. In this theme, we are pleased to republish an article that Ken Dike, our Executive Director of Planned Giving Services, wrote for one of our nonprofit clients. Ken explains the differences between charitable gift annuities and charitable remainder trusts and answers common questions on these investment vehicles.
What is a Charitable Gift Annuity (CGA) and what are the benefits? A charitable gift annuity is an arrangement whereby assets are given to a charity in return for the charity’s promise to make lifetime payments of a fixed amount to a beneficiary, who is often the donor. A CGA may be “deferred” in that the beneficiary payments may begin at a future date. The beneficiary receives income for life and the charity gets about half of the gift at the end of the annuity payments.
What is a Charitable Remainder Trust (CRT) and what are the benefits? In a charitable remainder trust, a beneficiary receives distributions from the trust and whatever remains in the trust when it terminates goes to charity. The beneficiary payments can be fixed in amount as in a charitable remainder annuity trust (CRAT) or vary each year based on the trust’s market value as in a charitable remainder unitrust (CRUT). The trust can last for the lifetime of the beneficiary or can terminate at a pre-determined date or upon the occurrence of a predefined event.
What is the difference between a CGA and CRT? Most charities follow the age-specific CGA beneficiary payout amounts suggested by the American Council on Gift Annuities (ACGA). The CRT donor can set any payout allowed by the IRS.
"The beneficiary payments from a CGA are guaranteed by the charity while CRT payments are subject to the availability of trust assets."
The beneficiary payments from a CGA are guaranteed by the charity while CRT payments are subject to the availability of trust assets. Since CRUT payments change each year based on the trust’s value, the income beneficiary and remainder charity share in any trust appreciation or decline in value. For these reasons, CGAs are favored over CRUTs by donors who are looking for certainty in their periodic payments and do not satisfy the current IRS-required beneficiary age minimum of 76 to qualify for a CRAT.
"...CGAs are favored over CRUTs by donors who are looking for certainty in their periodic payments...
A CRT is a separate legal entity created by the transfer of assets to a trust governed by the terms of a trust agreement that is administered by a trustee who may be the donor, beneficiary or the charity that receives the trust remainder at termination. Annual tax trust tax returns are required that produce a K-1 for the beneficiary income reporting based on the type and timing of the trust income. CGAs do not require a trust agreement, trustee, or annual tax return. Since the cost of creating and administering a CGA is significantly less than a CRT, CGAs are most appropriate for smaller gifts while CRTs are preferred by donors making large (>$250,000) gifts to a trust that can be invested at the discretion of the trustee.
"...CRTs are preferred by donors making large (>$250,000) gifts to a trust that can be invested at the discretion of the trustee."
What types of assets can be used to fund a CGA or CRT? Legally, nearly any type of asset can be used to fund a CGA or CRT. However, illiquid assets such as real estate are usually placed in a net income unitrust which is a type of CRT where the beneficiary distributions are limited to trust income. Except for net income unitrusts, the donated illiquid asset would have to be sold when received by the charity or trust in order to provide the liquidity required for the beneficiary payments. Additionally, there are California-imposed restrictions on how CGA funds must be invested that require about half of the assets to be held in government-backed bonds.
A charity issuing a CGA or serving as the trustee of a CRT may also have internal policies regarding what types of assets they will accept for these giving vehicles.
Is there a good age to open a CGA or CRT? Like many things in life, “it depends.” However, certain aspects of the two vehicles help answer this question from a general perspective.
The amount paid the income beneficiary of a CGA depends on the expected duration of the payments that is determined by the age of the beneficiary when the payments begin. CGA beneficiary payments may be deferred, accommodating young donors who want to receive beneficiary payments later in life. In general, the shorter the duration, the larger the payment. Donors that prioritize a larger payment should either delay payments or wait until they are older to open a CGA.
Due to their relatively large size, CRTs are usually created near retirement age in conjunction with the donor’s estate planning or following a significant financial event. Since the beneficiary payments can be stopped at a pre-determined time instead of continuing for the donor’s remaining life, the age of the donor is not necessarily a significant factor in the decision to create a CRT.
"...CRTs are usually created near retirement age in conjunction with the donor’s estate planning or following a significant financial event."
As with the type of donated asset acceptable by a charity issuing a CGA or serving as trustee of a CRT, the charity may have internal policies regarding the minimum age of a life beneficiary reflecting the charity’s concerns related to the duration of their future administration of these giving vehicles.
If I open a two person CGA or CRT are there any restrictions on who I can name as my second person? About any person who is alive when the CGA or CRT is created can be named as the second beneficiary, although there may be transfer tax implications if the other beneficiary is not the spouse of the donor. Under certain circumstances, even a trust or charity may be the beneficiary of a CRT.
How can these vehicles help both an individual and charity benefit? The donor, or those chosen by the donor, receive payments for their life or a term of years, and the charity receives whatever remains when the CGA or CRT terminates. The amount ultimately received by the charity (remainder) from a CGA will be about half of the initial gift value assuming the ACGA rates are followed. The remainder paid to charity by a CRT depends on the relationship between the trust’s investment returns and amount paid the beneficiaries. If the investment income exceeds the beneficiary payout, the charity will receive more than was transferred to the trust at inception.
"The remainder paid to charity by a CRT depends on the relationship between the trust’s investment returns and amount paid the beneficiaries."
The CGA and CRT donor also avoids the immediate recognition of capital gain income from donated appreciated securities and receives a tax deduction based on the market value of the assets donated, the amount paid to the beneficiaries, and the expected duration of the CGA or CRT.
The above information is for educational purposes and should not be considered a recommendation or investment advice. Investing in securities can result in loss of capital. Past performance is no guarantee of future performance.