Thursday March 28, 2024

3.3.3 Deferred Annuities

Deferred Annuities

Similarity to Current Annuities:   A deferred annuity is similar in many respects to a current annuity.

Deferral Period/Annuity Starting Date:   The principal difference between a current annuity and a deferred annuity is that the first deferred annuity payment is more than one year after the date of funding.

Charitable Deduction:   The charitable deduction for a deferred payment gift annuity is adjusted for the period of deferral through use of Table H from IRS Pub. 1457.

Deferred Annuity Funded with Appreciated Property:   For a gift annuity funded with appreciated property, so long as the annuitant is receiving the payouts and the annuity is nonassignable, except to the charity, the gain may be prorated over the life of the annuitant.

Similarity to Current Annuities


A deferred annuity is similar in many respects to a current annuity. The deferred annuity is a contractual agreement between the donor and the charity. It is secured by all of the assets of the charity. The parties with interests in the agreement to the contract are the donor, the charity, the annuitant or annuitants and the insurance commissioner of the appropriate state.

When the deferred annuity is created, part of the value represents a charitable gift and part is the amount exchanged for the annuity contract. The deferred annuity is also a bargain sale agreement subject to the same tax provisions. Reg. 1.1011-2. In addition, the deferred annuity must qualify under the same provisions as a current annuity. It must be for one or two lives, there must be a minimum 10% charitable deduction, there can be no guaranteed minimum or maximum payments, and the annuity may not be adjusted based on the income earned on the transferred property. Sec. 514(c)(5).

Deferral Period/Annuity Starting Date


The principal difference between a current annuity and a deferred annuity is that the first deferred annuity payment is more than one year after the date of funding. With a deferred annuity, there is a period of deferral until the annuity starting date. After the annuity starting date, the annuity is treated the same as a current annuity.

The annuity starting date is defined as the first day of the period that ends on the date of the first annuity payment. For an annuity that pays monthly, the annuity starting date is one month prior to the first payment. For a quarterly annuity, the annuity starting date is one quarter prior to that payment. Reg. 1.72-4(b)(1)(ii).

Since there is the period of deferral between the funding date and the annuity starting date, the deferred annuity pays a higher rate. During the period of deferral, the charity holds and invests the funds transferred. Since the charity will have a larger potential reserve to earn income, when the deferred annuity payments commence, there logically should be a higher rate.

With a long period of deferral, the rate could increase substantially. However, given the potential earnings of the charity, the payout on probable future annuity reserve will typically be less than a current annuity funded at that time. Since there is a longer period of deferral and a higher payout, the exclusion ratio and tax-free portions are lower than with current annuities.

Charitable Deduction


The charitable deduction for a deferred payment gift annuity is adjusted for the period of deferral through use of Table H from IRS Pub. 1457. The adjusted factor is then multiplied times the annuity payout to determine the value of the annuity. Subtracting this value from the amount transferred results in the charitable deduction.

The return multiple and exclusion ratio are calculated in a manner similar to the current annuity. The annuity starting date is used to determine the adjusted return multiple, expected return and exclusion ratio. With a deferred payment gift annuity, if Treasury issues new mortality tables between the funding date and the annuity starting date for the purpose of determining return multiples, it may be necessary to recalculate the return multiple and exclusion ratio at the annuity starting date.

Based on the exclusion ratio, the portion of the payout that is ordinary income and tax-free return of principal may be determined. If the deferred annuity is funded with appreciated stock for the donor's life or the lives of husband and wife, then the excluded portion is divided between the prorated long-term capital gain each year and the tax-free return of basis. If the annuitant or annuitants live past the adjusted return multiple, then all future payments will be ordinary income.

Example 3.3.3A

Mary Wilson transfers $20,000 cash to her favorite charity in exchange for a deferred payment gift annuity. The deferred payment gift annuity will pay 6.4% in ten years. The annuity of $1,280 times the factor adjusted for the quarterly payment and for the period of deferral produces a annuity contract value. Subtracting the annuity contract value of $13,632 from the gift amount of $20,000 produces a charitable gift value of $6,368.

Based upon Mary's adjusted expected return multiple of 19.6 years from the time payments commence, the estimated one-life payout is $25,472. Dividing the contract value by the expected return produces an exclusion ratio of 53.5%. Her total annuity of $1,280 then includes tax-free payout of $684.80. If she survives past life expectancy, all future payments will be ordinary income.

Deferred Annuity Funded with Appreciated Property


For a gift annuity funded with appreciated property, so long as the annuitant is receiving the payouts and the annuity is nonassignable, except to the charity, the gain may be prorated over the life of the annuitant. Reg. 1.1011-2(a)(4).

Example 3.3.3B

Mary Wilson owns stock that she purchased for $4,000 four years previously. The stock is now worth $20,000 and she transfers that to a charity in exchange for a deferred payment gift annuity. The deferred payment annuity agreement requires quarterly payments to her starting in ten years.

The deferred annuity times the adjusted factor equals an annuity contract value of $13,632, producing a charitable deduction of $6,368. Based upon her adjusted return multiple of 19.6 years from the time payments commence, there is a 53.5% exclusion ratio. The amount that is excluded from ordinary tax is divided between the capital gain and tax-free return. Based on the contract value prorated capital gain and her anticipated expectancy, the annual capital gain is $548.03 and the tax-free return of basis is $136.77. After life expectancy is reached, all future payments are ordinary income.

Case Studies on Deferred Annuities

The Home Equity Retirement Income Plan:   Thomas and Phyllis Adams, both age 65, have lived in their home on the Malibu cliffs for the past 25 years. Over those years, they have experienced mudslides, ravaging fires and earthquakes. Three years ago, their home was partially destroyed by the canyon fires well publicized in the news, but they have since rebuilt because they love the area. Their home is perched on a cliff overlooking the Pacific Ocean and the view is breathtaking. Most important, however, is that children and grandchildren are all within a couple hours' drive and they love spending time with them. Thomas and Phyllis hope to live in this home the rest of their lives, but they realize that during the years ahead many contingencies could arise that would require them to move.

Getting Back to the "Art of the Matter," Part 6:   Paulo Frambini, 45, is a talented artist and a self-proclaimed leader of the art purist movement. He lives, breathes and eats art history and culture. Paulo refuses to be characterized as any one particular type of artist. Accordingly, Paulo's artistic creations are very diverse and varied.

A Young Millionaire... What to do with All That Money?:   Beatrice McClaren, Executive Vice President of the local bank, made a gift to her daughter, Katrina, under the Uniform Gift to Minors Act. The gift consisted of 1,000 shares of stock in the bank where Beatrice is employed. Initially, the stock was worth only $10 per share, for a total transfer value of $10,000. Since the transfer was only $10,000, Beatrice used the annual gift tax exclusion and therefore no gift taxes were paid on the transfer. One of the main reasons for making the gift to her daughter is that any future appreciation in the stock would be shifted from Beatrice to her daughter, thereby reducing Beatrice's potential estate tax burden. Under the Uniform Gift to Minors Act, Katrina will receive the property from the custodian at age 21. Katrina is now age 18 and therefore the stock will be transferred to her in three years.


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