Basics of a Charitable Gift Annuity
Charitable Gift Annuities (CGA) are a very popular fundraising technique. A CGA is a contractual agreement between a donor and a charity where the donor transfers assets to the charity, and in return, the charity is obligated to pay a fixed amount to the donor or donors, for a specified term, usually for life.
The promise of a fixed income stream (and the associated income tax deduction) is the attraction to donors. The anticipated excess to the charity after the annuity term expires, is attractive to the charity. The problem is that there are significant risks to the charity associated with CGAs.
Economic Risk
A CGA, by its very nature, is unlikely to provide current income for a number of years (at retirement), and as a result there is a current cost to establishing a CGA program, and, as noted below, there is risk of significant economic loss to the charity.
For example, a charity (especially one with a limited number of CGAs) may not have the expertise to manage the CGA assets and/or the resources to make annual payments on the CGA without adversely impacting its other programs. If the annuity payments were expected to last for the donor’s life expectancy, but the donor lives beyond life expectancy, or the expected investment returns are not realized, the continued annuity payments might constitute a significant drain on the charity operations.
We have just gone through a period of time where high interest rates calculated into the annuities 20 years ago have not continued, causing a threat of insufficient assets to fund CGAs without using other resources.
When a charity receives a gift annuity, it usually has the option (in some states it is a requirement) to retain the annuity in a designated reserve fund and invest that fund (subject to applicable state restrictions if any). The charity may make payments from the fund (self-insure) or pay a premium to a financial services company that will then make the required annuity payments (re-insure). In addition, to the extent re-insured, with three notable exceptions, the charity is free to invest the remainder of the gift in accordance with its general investment policy. California, New Jersey and New York permit a reduction in reserves for special non-commercial type annuities (“true re-insurance”). True re-insurance insurance shifts the obligation from the charity to the insurer.
Funding Options
- Invest the entire amount of the gift, and make the income payments from the actual investment earnings. This may dictate a conservative investment philosophy[1], and tie up the use of the funds for an extended period of time. In some states, investment options are limited by statute or regulation. This also subjects the charity to double exposure from longevity and investment performance.
- Invest an amount of the gift that is equal to the present value of the future income stream to the donor and spend the rest. Not all states permit this, and where this option is available, the charity still bears the economic risks of lower than expected investment return and exceptional longevity.[2]
- Re-insure the CGA by purchasing an annuity (that will cover the entire annuity payment obligation) from a commercial insurance company using portion of the initial gift. This approach eliminates economic risk, and frees the remaining portion of the gift for immediate use.
In all cases, the decision will be based on the life expectancy of the donor, the confidence in estimated return on the charity's investments used to fund the annuity and the cost of re-insurance.
If you would like more information on this subject, or have a client who might benefit from a discussion about it, please contact Barry Koslow at bkoslow@mkaplanners.com or (781) 939-6050.
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[1] In some states, investment options are limited by statute or regulation.
[2] Some states require that the gift be segregated, and others require that the charity maintain a minimum statutory reserve. Most of the states that have reserve requirements permit the charity to reduce the reserve by any portion of the gift annuity that is re-insured through a commercial annuity issued by an authorized insurance company. Reducing the reserve requirement in these states has the added benefit of eliminating the investment restrictions applicable to the reserve.
