There are many ways to support charitable causes financially. There are outright cash donations, bequests in an estate, different types of charitable trusts, as well as charitable gift annuities. Today, we will focus on the latter.
"The promise of a reliable income stream is often attractive to donors."
Charitable gift annuities, or CGAs for short, are a popular planned giving vehicle and a mutually beneficial way to support a charity. It’s a win-win for both the charity and the donor. At its core, a charitable gift annuity is a contractual promise by a charity to provide secure fixed payments to a donor or income beneficiary for life in exchange for a gift of cash or securities. The promise of a reliable income stream is often attractive to donors.
Before establishing a charitable gift annuity, it is important to consider both the potential risks and benefits to the donor:
CGA RISKS TO THE DONOR
Mortality risk and purchasing power risk are likely the most important potential concerns for a donor to assess. The first occurs when the donor dies before his or her actuarially expected age and is therefore unable to benefit from the full income stream accounted for when the annuity contract was written. Purchasing power risk is the possibility that the annuity payout rate may not keep up with inflation. While exceptionally rare, default risk, wherein the charity is unable to pay the lifetime income stream, can happen if the charity’s financial resources are insufficient or mismanaged. Following the American Council on Gift Annuities’ payout guidelines (discussed below) is an important best practice charities can adhere to—and most do—for a sustainable gift annuity program. Finally, these are irrevocable gifts, meaning you can’t take it back—a donor must be comfortable with this commitment.
"Mortality risk and purchasing power risk are likely the most important potential concerns for a donor to assess."
CGA BENEFITS TO THE DONOR
In addition to fulfilling a desire to support a charity, the donor receives an immediate income tax deduction and fixed, stable income for his or her lifetime. Also, the donor can avoid capital gains tax if he or she gives appreciated stock. If the donor dies before the actuarially expected year, his or her estate can apply the unrecovered investment in contract (missed payments due to shorter-than-expected life) as an itemized deduction on the donor’s final income tax return.
Beyond these evergreen qualities, payout rates for CGAs are increasing in today’s rising interest rate environment, making this planned giving vehicle more attractive to donors.
UNDERSTANDING CGA PAYOUT RATES
The American Council on Gift Annuities (ACGA) suggests maximum charitable gift annuity rates that are used by most charitable institutions when issuing gift annuities. Since 1955, the ACGA has targeted a residuum (the amount remaining for the charity at the termination of the annuity) of 50% of the original contribution for the gift annuity. Importantly, this makes it very likely that the annuitant will reliably receive distributions and that the donor’s charitable intent is realized at the conclusion of the annuity.
In addition to this target residuum, other major assumptions behind ACGA-recommended annuity payout rates include mortality assumptions, investment return assumptions, expense assumptions for investment and administration, and annual payments made in quarterly installments at the end of each period.
The largest component of the ACGA expected return calculation is based on the 10-year U.S. Treasury bond yield. Increases in yield can lead to an increased investment return assumption for fixed income in the ACGA model, resulting in a higher overall investment return assumption.
"The largest component of the ACGA expected return calculation is based on the 10-year U.S. Treasury bond yield."
ACGA investment return assumptions ranged from 6.00% to 6.75% between 1999 and 2006. Due to the Great Financial Crisis and the impact of the Federal Reserve’s accommodative stance on interest rates, the ACGA investment return assumptions declined to 4.25% by January 2012. The ACGA last raised its investment return assumption in July 2018 from 4.25% to 4.75%, only to decrease its investment return assumption 18 months later (January 2020) back down to 4.25% from 4.75%. Six months later (July 2020), the ACGA further lowered the investment return assumption to 3.75% presumably due to the unpredictability surrounding the COVID pandemic lockdown and more interest rate accommodations by the Federal Reserve.
Most recently, the ACGA Board announced that the investment return assumption would increase from 3.75% to 4.50% (an increase of 0.75%), effective July 1, 2022. As a result of this increase, most recent payout rates will increase anywhere from 0.4% to 0.6% depending on the age of the annuitant. The chart below shows how the payout has changed over the last 20 years or so for a single life 79-year-old, relative to the ACGA gross investment return assumption and the 10-year U.S. Treasury.
Since donations to charitable gift annuities don’t require as large an outlay as, say, a charitable trust, you can assist your favorite philanthropy in a small but meaningful way and also receive a steady income stream. The table below shows the increases in annuity payments before and after the July 1, 2022 ACGA recommendations for varying gift annuity amounts.
With payout rates increasing, now might be a good time to establish a charitable gift annuity, if this approach to giving interests you. You can also consider laddering CGAs in a rising interest rate environment since the minimum amount to fund a gift is relatively low. Your investment counselor can help you evaluate charitable gift annuities within the context of your overarching philanthropic strategy and financial goals.
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.