When clients express interest in charitable gift annuities (CGAs), the purchase decision usually begins with a charitable intent. In other words, they have a high interest in financially supporting a favorite charity that will issue a CGA and also by the way, reap some nice tax benefits along the way.
However, in the mortality based income world, I believe there is plenty of room at the table for both CGAs and commercial SPIA contracts. In fact, many people own some of each. Why is that? Annuity consumers crisscross ownership lines because; there are some important economic differences.
The current CGA market, with annuity rates established by the American Council on Gift Annuities (ACGA) indicates; a female age 80 (known as the Beneficiary), might purchase a CGA with a $100,000 payment and reap an immediate tax deduction of about $49,000 that maybe fully or partially utilized in the purchase year, depending on her income tax status. The higher her effective income tax rate the more valuable the deduction. For example; if the entire $49,000 deduction can be utilized in the purchase tax year and she is in a 25% tax bracket then, this results in a $12,250 ($49,000 x 25%) tax liability savings. There is a five year carry forward provision for individuals who cannot utilize the entire tax benefit in the purchase year.
In addition, she receives a CGA monthly income of about $567 with $442 as the non-taxable portion and $125 as the taxable portion due to IRS lifetime expectations (about 9.60 years) impacting the premium cost recovery. In this case, the exclusion ratio is determined by the remaining $51,000 capital sum and not the $49,000 portion associated with the tax deduction. The contract issued and guaranteed by the charity terminates when she dies with the residual value going to the charity. This is your basic immediate income CGA.
However, a commercial life-only SPIA for the same individual (Annuitant) indicates a monthly payment of about $800 with the entire annual income being non-taxable. Due to old IRS annuity cost recovery tables (producing shorter annuity premium cost recovery periods due to shorter lifetime expectations) , combined with the ultra low interest rate environment and ever increasing carrier longevity estimates , none of the SPIA income is taxable until the cost basis is recovered first. After that time, about 10.41 years, when she is past age 90, the SPIA income becomes 100% taxable. In this case, the commercial SPIA produces an on-going FIFO tax benefit for this age and gender individual.
The total tax benefit utilization needs to be weighed between the competing contracts. Keep in mind States regulate charities and also commercial carriers by setting financial reserving standards, establishing uniform contract language and ongoing financial health monitoring, among other things. However, because commercial carriers are subject to State financial assessments, State established annuity contract limit guarantees only extended to commercial carriers.
Overall, both contract owners receive the mortality pooling protections from financial asset dissipation problems associated with other financial products. Because both contracts don’t have cash values, these individuals can’t become compelled by some third party to reduce their contract value. At older ages, if they become dispossessed of other assets for whatever reason and there are a lot of them, they are going to retain these annuities.
Mortality pooled annuity contracts are long-term defensive financial products. While good offense; financial risk taking (stocks and bonds) is important and exciting and sells lots of tickets to the game, its great defense that wins championships (Coach Paul “Bear” Bryant). That’s the idea “Always Keep Your Hands Up!”