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Introduction

For individuals at various stages of their careers, retirement planning is an important topic of interest. For those who are charitably minded, charitable gift annuities (CGAs) can serve as a valuable tool for planning and enhancing retirement security. With CGAs, donors can make significant charitable contributions that provide them with tax advantages while securing a fixed payment stream. Since CGAs can be tailored to different financial and charitable goals, CGAs can serve as a versatile option for retirement planning.

In the first installment, we discussed the fundamentals of CGAs, including the basics, the general registration requirements, benefits and the two primary variations of CGAs: immediate and deferred. In this second installment, we will delve into strategic CGA options for individuals approaching retirement, including discussions of flexible deferred CGAs, term-of-years CGAs and CGAs funded with a qualified charitable distribution (QCD). By exploring the different ways CGAs can be structured, professional advisors can maximize a donor’s retirement benefits and support a donor’s charitable causes.

Flexible Deferred CGAs

As noted in the first installment, a standard deferred CGA involves delaying the payout for one or more years, with a fixed, predetermined payout date. The drawback of this setup is that the annuitant is committed to a specific payment date and amount. If he or she prefers to retire sooner or later than the specified date, the annuity cannot be adjusted.

In a private letter ruling (PLR), the Internal Revenue Service (IRS) approved the concept of a Flexible Deferred CGA (Flexible DCGA). PLR 9743054. It is worth noting that while a private letter ruling cannot serve as legal precedent, it can provide insight into the IRS’ likely position on a given issue.

With a Flexible DCGA, the donor chooses a target retirement date and age, but the contract gives the donor the flexibility to begin payments either earlier or later than the target date. However, since the charitable income tax deduction is based on the target date, starting the annuity sooner would result in a reduced payout. The payout is adjusted to maintain the same charitable deduction value as initially calculated. If the donor opts to delay payments beyond the target date, the donor will benefit from an increased annuity payment due to the extended deferral, while the charitable deduction will remain the same.

Payout rate adjustments that vary from the target dates will be determined by the donor's age at the time payments begin, factoring in the deferral period from funding to the start date, with the start date being one payment prior to the first payment date. Consequently, the tax-free portion will be adjusted in line with the ACGA payout rate. Some donors may prefer the option of a reduced payout earlier, while others may delay payments in order to receive a higher payout if income is not immediately needed. Finally, some may decide they no longer need the income and choose to donate the contract to charity, allowing them to receive an additional charitable income tax deduction at that future date.

Example A

Belinda is a 55-year-old business owner who has been focusing on growing her company and building a financial portfolio over the last 20 years. Because she is approaching 60, she is starting to give more thought to her current retirement plans. She realizes she will need additional income to supplement her retirement when she does decide to retire.

She is active in her community and passionate about charitable causes, so she considers a Flexible DCGA because she is uncertain about the exact year she wants to retire.

Belinda transfers $100,000 cash to her local nonprofit to fund a Flexible DCGA. She elects age 65 as the target date and she receives a deferred annuity rate of 9.1% with a charitable income tax deduction of $33,711. Because it is a Flexible DCGA, Belinda’s contract allows her to start receiving payments at any age between 60 and 80. However, the annuity rate will be adjusted accordingly.

The nonprofit explains the possibilities. If Belinda needs the income at 60 years old, her annuity rate will be 6.19%, totaling $6,196.80 per year with approximately $2,739 in tax-free income. If she prefers to defer the income until she is 70, she will get a 12.6% annuity rate totaling $12,600 with approximately $4,145 in tax-free income.

Election

In a Flexible DCGA, when an annuitant wishes to start the payments during the time range, they must elect to do so by written notice to the nonprofit. If the annuity is a two-life annuity, this election may be made by either annuitant. The annuity contract usually requires that an election be made one payment period prior to the desired annuity start date.

Term-of-Years CGAs

Some individuals may prefer supplemental income between their initial retirement date and the start of another retirement plan. In these cases, donors may want CGA income only for a specific number of years, making a term-of-years CGA a suitable option for their needs.

While a qualified CGA must initially be written for one life or two lives under Sec. 514(c)(5), the IRS has approved the term-of-years CGA structure. General Counsel Memorandum 39826, PLR 200233023 and PLR 9042043. Under this authority, donors may elect to convert a deferred one-life or two-life annuity into a term-of-years option before the annuity starting date. While this is generally accepted by the IRS, it is important for the nonprofit’s legal counsel to ensure compliance with the organization's policies and state-specific regulations. Not all states will approve of this structure (such as New York).

Conversion to a Term-of-Years CGA

A term-of-years CGA must begin as a one or two life deferred CGA and follow specific requirements, including that the contract cannot guarantee a minimum or maximum number of payments. Sec. 514(c)(5). To meet these requirements, the CGA should be set up as a deferred one or two life CGA, with the option to convert to a term-of-years payout written into the contract at its creation. If the CGA was set up as an immediate term-of-years annuity, it would be subject to excise tax due to generating unrelated debt-financed income and the annuity obligation would be treated as acquisition indebtedness. By structuring the term-of-years as an optional, one-time election made by the annuitants, the CGA avoids any initial commitment to a specific term duration, which allows it to meet the requirements of Sec. 514(c)(5). Furthermore, a conversion to a term-of-years duration not only allows for fixed payments over a specific period but, because it condenses the payments from a lifetime to a term of years, it often results in higher annuity payouts for the limited term.

Under current law, electing the term-of-years annuity option for a person under the age 59½ triggers a 10% excise tax on early withdrawals. Sec. 72(q). For any payments made before reaching age 59½ the excise tax will be applied, so structuring the term of years to ensure payments start no earlier than age 60 will help minimize penalties.

Example B

Enrique is 58 years old. He desires to create an agreement that would provide supplemental income between ages 65 and 73 since he plans to retire at age 65, but he will start taking withdrawals from his IRA at age 73.

Enrique uses an asset with a cost basis of $30,000 and a fair market value of $100,000 to fund a one-life deferred CGA with a term of years election. The deferred payment gift annuity will pay him $7,800 per year. The agreement also includes an option allowing Enrique up to three months to elect to convert the deferred one-life annuity into a term of eight years. Within two months, Enrique provides written notice to the charity, opting for the eight-year-term payments.

Enrique receives a charitable gift deduction of $34,275. The annuity contract value allows him to receive an annuity of $14,118.24, nearly double the annual payment he would have received if the deferred annuity were based on his lifetime. Of this amount, $2,464.70 is tax free, $5,750.95 is capital gain and the balance is ordinary income. Enrique receives the payout for eight years and then starts taking withdrawals from his IRA.

Qualified Charitable Distributions

IRA owners 70½ and older, especially those already retired and seeking ways to reduce their taxable income, can benefit from a QCD or IRA charitable rollover. Sec. 408(d)(8). In most cases, QCD gifts will be transferred from a traditional IRA to a public charity for the general purposes of the charity, but they may also be used to fund a field of interest fund or for another qualified charitable purpose. The 2024 annual limit on outright QCDs is $105,000, which is indexed for inflation and will be increased to $108,000 in 2025.

By utilizing the QCD, donors can avoid recognizing the transferred amount as taxable income, effectively lowering their adjusted gross income (AGI). Additionally, QCDs can count towards satisfying an IRA owner’s required minimum distributions (RMDs) for the year, which can make it a highly effective strategy for managing taxable income. When an IRA owner reduces their IRA account with QCDs, they also reduce the size of their future RMDs since RMD amounts are calculated based on the IRA balance. A smaller IRA balance will result in a smaller RMD, and in turn, can result in lower taxable income in the years thereafter.

SECURE 2.0 Act

The SECURE 2.0 Act, enacted in late 2022, introduced significant enhancements to IRA rollovers. Section 307 of the SECURE 2.0 Act allowed a once-in-a-lifetime rollover under Sec. 408(d)(8)(F) of $50,000 from an IRA to a life income plan. This $50,000 limit has been indexed for inflation and is currently at $53,000 in 2024, with an increase to $54,000 in 2025. The IRA distribution can be made to a Charitable Remainder Annuity Trust (CRAT), a standard Charitable Remainder Unitrust (CRUT) or an immediate CGA.

Certain conditions will apply for QCD-funded split interest gifts. For CGAs, the payout rate to the annuitant must be 5% or higher, and the contract cannot be assignable back to the charity. Additionally, the lifetime income must only benefit the IRA owner, the IRA owner’s spouse or both. Unlike typical split interest gifts, there is no charitable deduction, and all payments made to the annuitants must be taxed as ordinary income.

The QCD to CGA approach may appeal to donors who are looking for predictable lifetime payments to supplement other retirement income.

Example C

Olivia is a 75-year-old retiree. She has a traditional IRA and has been taking her RMDs since turning 73. Olivia knows the RMDs increase her taxable income each year, which she would like to minimize.

Olivia learns about QCDs and their benefits, including the option to fund a CGA. Olivia decides to fund a one-life CGA using her one-time IRA charitable rollover and elects to transfer the maximum amount for 2024 of $53,000. By rolling over the maximum allowable $53,000 to establish a one-life CGA, Olivia qualifies for a payout rate of 7%, based on her age. This guarantees her an annual annuity of $3,710 for the rest of her life. Over her projected life expectancy, Olivia is expected to receive a total of $63,441 in payments.

With this strategy Olivia was able to avoid recognizing the entire $53,000 QCD to fund a CGA as taxable income for the current tax year. Instead, she gradually recognizes the income as she receives her annuity payments, which are taxed as ordinary income. This approach not only helped spread her tax liability, but it also reduced her IRA account balance while meeting her charitable goals.

Conclusion

In this article, we discussed the flexible DCGA and term-of-years CGA as strategic options for near-retirement donors, highlighting their unique benefits in terms of timing and payout structure. We also touched on CGA options of using QCDs to fund CGAs to manage and reduce taxable income.

Immediate and deferred CGAs offer great solutions for individuals looking to create fixed payment streams to supplement retirement income. In comparison to an immediate CGA, donors who opt for deferred CGAs may benefit from a larger charitable deduction and the flexibility to access funds when needed the most. Because this flexibility appeals to a wider range of donors, more specifically the donors who are near-retirement age, nonprofits can broaden their donor pools by engaging with donors that they may have otherwise overlooked due to age. By understanding and offering diverse CGA structures, professional advisors and nonprofits can become well-equipped to guide donors through their retirement income options while supporting charitable causes.