GIFTS THAT ENHANCE YOUR INCOME

by Mark A. Zlotnik, C.A., CLU

Part A: Gift Annuities

Many individuals provide for charitable organizations, by making a bequest in their will. Many of these same individuals have had their current after-tax income reduced because of lower interest rates. Also, the full tax benefit of the charitable donation under the will may not be available (i.e. there may not be enough income in the year of death and the immediately preceding year to fully utilize donations resulting from bequests in the will).

There are various methods of enhancing a donor's after-tax investment returns while the donor is living. One of these methods is through a "gift" annuity which is explained in this article.

Another method is through combining the financial vehicles of a life annuity and a life insurance policy in an "insured" annuity which will discussed in another article.

A gift annuity works essentially as follows:

  1. A donor transfers an amount to the charitable organization.
  2. The charitable organization undertakes to make annual or monthly payments to the donor for life or for a fixed period of time.
  3. The amount of the payment and the life expectancy of the donor are used to determine whether all of the payments to the donor are non-taxable or what portion of the payments are taxable. This information is also used to detennine whether a charitable receipt can be issued by the charitable organization for the transaction.
  4. A table is used to determine life expectancy for the purpose of charitable gift annuities. A part of this table is summarized in Table "A".
TABLE A
Expected # of Annual Payments
Age Male Female
60 22 26.3
65 18.6 22.0
70 15.0 17.9
75 11.7 14.0
80 9.0 10.6

1. The annual payment that can be made by the charity to the donor on a tax-free basis is determined by dividing the total amount of the contribution to the charity by the life expectancy. For example, a 75 year old female could transfer $1 00,000 to a charity. That individual's life expectancy per the table is 14 years. This means that $7,143 could be received by that individual from the charity each year without paying any tax. If that individual was in a 50% tax bracket, the individual would have to earn 14.3% interest before tax to be in the same position after tax. Table "B" shows the amount of annual payments that can be made to an individual on a tax-free basis based on age and gender. Table "C" shows the pre-tax equivalent yield based on the payment in Table "B".

TABLE B
Maximum Tax-Free Annual Payment
(based on $1 00,000 contribution) 		  TABLE C

Pre-Tax Equivalent Yield at 50% Tax Rate
Based on Payment in Table A
Age Male Female Age Male Female
60 $4,425 $3,802   60 8.8% 7.6%
65 $5,376 $4,545   65 10.7% 9.1%
70 $6,667 $5,586   70 13.3% 11.2%
75 $8,547 $7,143   75 17.1% 14.3%
80 $11,111 $9,434   80 22.2% 28.6%
        Note: This is the interest rate you would have to earn to have the same income after tax.

 

  1. If the donor negotiates a higher payment from the charity than the amount shown on Table "B", a portion of the payment would be taxable.
  2. If the individual takes a lower payment than the amount on Schedule "B", then a charitable receipt will be issued. The amount of receipt is equal to the amount contributed to the charity, less the expected payments. The expected payments are the annual payment multiplied by the life expectancy, as per Table A.

This type of transaction can result in a significant increase in after-tax income to an individual. Any questions should be directed through the development office.