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Wednesday, May 1, 2024
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Case Studies |
Soft Markets and Low Interest Rates, Part 1 – CDs and Money Market Accounts
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Case:
Jeanne Henry, 77, is a very concerned American. Having grown up during the Great Depression, Jeanne developed certain attitudes towards money and savings. As a result, she saved consistently and conservatively during her entire life. Despite her financial planner's suggestions, Jeanne put little, if any, of her savings into the stock market. Consequently, Jeanne avoided large losses in retirement savings that may occur during market downturns.
However, the decreasing interest rates have caused Jeanne's CD and MMA interest rate returns to dwindle. Currently, Jeanne is earning a mere 1.5% on her savings. While happy she preserved the principal of her accounts, Jeanne's yearly retirement income has dropped off significantly which displeases her. She wants to increase her income substantially but does not want to expose herself to any market risk.
Question:
How can Jeanne increase her return on investment without exposing her to fluctuations in the markets?
Solution:
Jeanne should consider using some of her CD and MMA accounts to fund a charitable gift annuity ("CGA"). At age 77, Jeanne would receive a 6.6% payout. Moreover, Jeanne currently pays ordinary income tax on all earnings from her savings accounts. However, if she funded a CGA, she would pay ordinary income tax on about 35% of the payout and the remaining 65% would not be subject to any tax whatsoever. Because she does not itemize, the low applicable federal rate (AFR) produces a large annual benefit. In some cases, the highest AFR is selected because it will produce the highest charitable deduction. However, when a donor does not itemize or desires more tax-free income, then the lowest AFR should be selected. In this case, Jeanne does not itemize, so a large charitable deduction is not important.
Since Jeanne chose a financially-strong charity, Jeanne has exposed herself to very little risk. CGAs are backed by the full faith and credit of the issuing charity. Therefore, as long as the charity remains financially viable, Jeanne will continue to receive a fixed payout for the rest of her life.
Jeanne loves the increase in her income, the tax-free portion of each payout and the certainty of a payment each year. Thus, she transferred about 25% of her saving accounts in exchange for a gift annuity. In the end, Jeanne accomplished all of her goals while still adhering to her deeply-rooted beliefs regarding savings and money.
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