Friday April 19, 2024

3.4.3 Testamentary Gift Annuity

Testamentary Gift Annuity

Benefits of a Testamentary Gift Annuity:   Gift annuities may be created for one life or two lives.

Testamentary Gift Annuity Beneficiaries:   There are many options available for a testamentary gift annuity.

Testamentary Current or Deferred Gift Annuity?:   If the beneficiary is reasonably senior, it may be appropriate for the decedent to create a testamentary immediate gift annuity.

Testamentary Gift Annuities


A gift annuity is a contract between the charity and the donor. The donor transfers property to the charity and the charity promises to pay the annuity for one life or two lives. Sec. 514(c)(5).

As a contractual obligation, the annuity payments are secured by the assets of the charity. Most charities maintain an annuity reserve fund, which is required by some state insurance commissioners. However, the endowment and all of the real property and other assets of the charity stand behind the promise to pay a gift annuity. Most nonprofits who issue gift annuities have large reserves that assure the full payments will be made.

Many senior donors are delighted with their personal gift annuity and would like to leave part of their estate to fund gift annuity payments to a child, spouse, sibling, nephew or niece. If the donor is senior and passes away in his or her 90's, the beneficiary receiving the gift annuity payments may be age 70 or more. Fixed payments for this individual may be an excellent plan. This testamentary gift annuity may be funded with cash from the estate or a qualified retirement asset such as an IRA.

Benefits of a Testamentary Gift Annuity
Gift annuities may be created for one life or two lives. While most gift annuities are created with the same donor and annuitant, it is entirely permissible to create a charitable gift annuity for another person.

If a parent or other donor desires to create a fixed payment stream for a child or other beneficiary, a testamentary gift annuity may be an excellent option. The testamentary gift annuity may be funded from an estate or a revocable trust. The personal representative (executor) transfers a designated sum to a qualified public charity to fund the gift annuity.

The donor may have several reasons for preferring the fixed payment of a gift annuity to the potentially variable payments from a trust. He or she may have a specific economic benefit that is appropriate for a child, a brother, a sister or other relative. The fixed payments of the gift annuity are secured by all of the assets of the charity and the decedent may prefer this high level of security for the payouts. Finally, there will be a charitable estate tax deduction for part of the value allocated to the gift annuity.

Testamentary Gift Annuity Beneficiaries
There are many options available for a testamentary gift annuity. First, under Sec. 514(c)(5) a qualified gift annuity must be for one life or two lives. A testamentary gift annuity is often created for a child, grandchild, brother, sister or family friend.

It is also possible to create a testamentary gift annuity for a surviving spouse. While Reg. 20.2056 (b)-(g), Example 7, suggests that there will not be a marital deduction for such an annuity, Sec. 2056(b)(7)(c) explicitly allows a QTIP marital deduction for survivorship gift annuity interests. In a manner similar to the charitable remainder annuity trust or testamentary pooled income fund, all of the income from the interest is transferred from the spouse, with an additional benefit to charity.

When there is a conflict between the Code passed by Congress and regulations published by the IRS, courts invariably follow the Code. Therefore, it seems nearly certain that the Sec. 2056(b)(7)(C) deduction will be permitted for a spousal testamentary gift annuity. However, if the estate is substantial and therefore taxable, a donor may choose instead to fund a charitable remainder annuity trust for the spouse and be assured of the Sec. 2056(b)(8) marital deduction for a spousal remainder trust.

Testamentary Current or Deferred Gift Annuity?
If the beneficiary is reasonably senior, it may be appropriate for the decedent to create a testamentary immediate gift annuity. This annuity would commence payment to the beneficiary upon the death of the decedent.

However, because some beneficiaries may be relatively young in age it may also be appropriate to consider a testamentary deferred payment gift annuity. With a deferred payment gift annuity, the donor is likely to select a specific beneficiary age to commence payouts. For example, the deferred gift annuity may commence payments when the beneficiary reaches age 65. If the donor lives to a senior age and the beneficiary has reached the designated age for payout by the demise of the donor, then an immediate or current gift annuity will be funded by the estate.

Example 3.4.3A Testamentary Current Gift Annuity

Mary Wilson was in her 80s and enjoyed the benefits of a gift annuity. She received high fixed payments and a substantial charitable income tax deduction. In addition, a portion of her payment was tax-free return of principal.

Since Mary was very pleased with her gift annuity, she decided to create a gift annuity for her daughter Susan. Mary directed her attorney to include the following language in her will:

"I hereby direct my personal representative to allocate the sum of $100,000 from the residue of my estate to favorite charity of Chicago, Illinois for the purpose of funding a charitable gift annuity for my daughter Susan Jones. The gift annuity shall make payments at the one life gift annuity rate according to the published schedule of favorite charity on the date of my death. Payments shall be quarterly at the published rate for Susan based on her age at the date of my demise. If Susan shall not survive me, then the $100,000 shall be an unrestricted charitable bequest to favorite charity."

If Susan is age 63 when Mary passes away, the $100,000 gift annuity will pay 5.4% to Susan for her lifetime. While the $100,000 is includable in Mary's estate, there is a Sec. 2055(e) charitable estate deduction of $32,313, resulting in a taxable transfer of $69,369.

Susan will receive gift annuity payments for her lifetime. With the $4,700 annuity, $3,402.80 of the payout will be tax-free and $1,297.20 will be ordinary income. If Susan lives longer than her estimated life expectancy, all further payments will be ordinary income.

Example 3.4.3B Testamentary Deferred Gift Annuity

Bill Smith would like to provide additional retirement security for his daughter Ellen Smith. Ellen is now 60 and plans to retire at age 65. To provide this benefit for Ellen, Bill directed his attorney to include this language in his will:

"I hereby direct my personal representative to allocate the sum of $100,000 to favorite charity for the purpose of purchasing a one-life deferred payment gift annuity for my daughter Ellen Smith. The deferred annuity shall pay the published favorite charity rate based upon Ellen's age on the date of my death. Payments shall be quarterly and the first payment shall commence on Ellen's 65th birthday. If Ellen shall be age 65 or older when I pass away, the $100,000 amount shall fund a one-life immediate gift annuity at the published rate based upon Ellen's age on the date of my demise. If Ellen shall not survive me, then $100,000 shall be allocated as an unrestricted charitable bequest to favorite charity."

Bill was terminally ill with cancer at the time he completed his last will and he passed away a few weeks later. His personal representative transferred $100,000 to favorite charity for a deferred payment gift annuity for Ellen.

Based upon Ellen's age, the period of deferral and the payout rate, there was a substantial estate tax charitable deduction. While the $100,000 was an estate asset and includable in the estate, Bill's estate received a Sec. 2055 (e) charitable estate deduction of $32,657. When Ellen reaches age 65, she will receive an annuity payout of $5,500. Since the principal allocated to the annuity is prorated over the life expectancy of Ellen, $3,382.50 of this amount will be tax-free and $2,117.50 will be taxed as ordinary income.

Private Letter Rulings

PLR 200230018 IRA to Testamentary Gift Annuity:   In PLR 200230018, the Service ruled favorably on the IRA owner's request to fund a testamentary charitable gift annuity. While a private letter ruling is not a precedent, it is a useful indication of the tax analysis of the Service with respect to any particular issue. There were five specific favorable aspects to the ruling.

Related Topics on Testamentary Gift Annuity

3.3.9  Income, Gift and Estate Taxes:    The major benefits of a charitable gift annuity are an income tax charitable deduction and partly tax-free payments. Reg. 1.1011-2(a). In addition, if the donor/annuitant passes away prior to his or her life expectancy, the unrecovered basis may be deducted on the final income tax return as a miscellaneous itemized deduction not subject to the 2% limit. Sec. 72(b)(3) and Sec.67(b)(10).

3.4.2  Flexible Annuity:    With a standard deferred annuity, the payout is deferred for one or more years. However, there is a fixed date for payout. The disadvantage of the standard deferred annuity is that the annuitant is locked in to a specific payment date and amount. If he or she desires to retire earlier or later, the standard deferred annuity does not change. Deferred annuities would be more attractive to donors if there were greater flexibility, similar to the options available with a commercial annuity.

3.4.6  IRA to Testamentary Gift Annuity:    IRAs and pension plans have grown dramatically in aggregate size during the past decade. Even with the reduction in value due to the stock market, Federal Reserve data suggest that there is approximately $3 trillion in IRAs and over $10 trillion in cumulative qualified plans.

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