Sunday April 28, 2024

6.3.3 Term-of-Years Annuity

Term-of-Years Annuity

Charitable Income Tax Deduction:  The fair market value of the contributed property, the corresponding payout rate, the applicable federal rate (AFR), the beneficiary's age and the payment frequency are all needed to perform the deduction calculation.

Taxation of Annuity Payments:  One of the major benefits of a charitable gift annuity is partly tax-free income.

Term-of-Years Annuity Option Worksheet:  The worksheet below demonstrates the compressed payout schedule.
With a term-of-years gift annuity, the donor receives a charitable tax deduction and income for a period of years. As long as the annuitant elects the term-of-years option prior to the annuity starting date, the annuitant receives payments that are partially taxed as ordinary income and partially tax-free. If the election is made after the annuity starting date, the payments are immediately taxable in full to the annuitant. Therefore, annuity contracts should be written to permit the term-of-years election only prior to the first annuity payment date. Under current law, electing the term-of-years annuity option for a person under age 59½ triggers a 10% excise tax on early withdrawals. Sec. 72(q). However, this penalty typically is lessened by the tax-free portion of the annuity payments.

Charitable Income Tax Deduction
The fair market value of the contributed property, the corresponding payout rate, the applicable federal rate (AFR), the beneficiary's age and the payment frequency are all needed to perform the deduction calculation. The charitable deduction for a deferred payment gift annuity is adjusted for the deferral period using Pub. 1457, Table H.

To illustrate how the deduction is calculated, consider Jane Donor who creates a charitable deferred gift annuity on January 1, 2018 to begin paying January 1, 2023. The fair market value of the property used to fund the annuity is $100,000. Based on her age and the ACGA recommended deferred gift annuity rates Jane will receive a 7.7% payout rate. The AFR for the month of January is 2.6% and Jane has selected quarterly payments. Using this information and IRS Pub. 1457, the charity's gift planner creates the following charitable deduction worksheet.

           
Deferred Payment Gift Annuity -- One Life
  Donor: Jane Donor Prop. Value: $100,000.00  Gift Date: 01/01/2018  
  1st Person: Jane Donor Birth Date: 06/01/1943  Pay Date: 01/01/2023  
  Cost Basis:         $100,000.00 IRS Ann. Starting Date:   10/01/2022  
  Payment Freq.:   Quarterly             (Payments at End of Selected Period) Annuity % 7.700000    
 
     
 (A) Annual Payout: $7,700.00 (A) 
       Gift Amt. x Annuity %
       AFR of the Month:   2.6%		    
 (B) D Factor:    
       Age:   79 7086.096813 (B) 
       Age:   75 9417.121863 (B) 
       (IRS Pub. 1457, Table H)    
   
 (C) D Factor/D Factor: 0.752469 (C) 
 (D) Unadjusted Value $1, Ann. Start Age: 7.5469 (D) 
       (IRS Pub. 1457, Table S)    
 (E) Adjustment for time of Payment: 1.0097 (E) 
      (IRS Pub. 1457, Table K)    
 (F) Adjusted Factor: 7.6201 (F) 
       Line(D) x Line(E)    
 (G) Value $1 of Deferred Annuity: 5.7339 (G) 
       Line(C) x Line(F)    
 (H) Present Value of Annuity: $44,151.03 (H) 
       Line(G) x Line(A)    
 (I) Amount Transferred: $100,000.00 (I) 
 (J) CHARITABLE GIFT VALUE $55,848.97 (J) 
       Line (I) less Line (H)    

Deferred Payment Gift Annuity -- One Life
 (K) Unadjusted Expected Return Multiple 10.0 (K) 
       (Reg.Sec. 1.72-9, Table V)
 (L) Adjustment if Not Monthly -0.1 (L) 
       (Reg.Sec. 1.72-5(a)(2))
 (M) Adjusted Expected Return Multiple 9.9 (M) 
       Line (K) Plus Line (L)
 (N) Expected Return $76,230.00 (N) 
       Line (M) Times Line (A)
 (O) Exclusion Ratio 57.9% (O) 
       Line (H) Divided By Line (N)
 (P) Amt Excluded From Ordinary Tax $4,458.30 (P) 
       Exclusion Ratio Times Annuity
       (I.R.C. Sec. 72(b)(3))
 (Q) Basis Allocated to Annuity $44,151.03 (Q) 
       Basis Times Line (H)/GIFT
 (R) Gain Allocated to Annuity $0.00 (R) 
       Line (H) Less Line (Q)
 (S) Capital Gain Each Year $0.00 (S) 
       Line (R) Divided By Line (M)
       (Not to Exceed Line (P))

           
SUMMARY OF DEFERRED PAYMENT GIFT ANNUITY
  Date of Annuity 01/01/2018 Initial Age 75
  Date of First Payment 01/01/2023 Start Age 79
      Payment Age 80
  Amount Transferred   $100,000.00    
  Annual Annuity   $7,700.00    
  Char. Deduction   $55,848.97    
     EXCLUSION RATIO UNTIL 2032  57.9%  
      (If current IRS Tables effective)    


The charitable deduction worksheet provides all the relevant calculation assumptions, steps and IRS publication references. The first box delineates Jane's name, the annuity payout percentage, the payment date and frequency and the gift amount. This information is used to calculate Jane's charitable tax deduction.

The second box provides the steps taken to determine the charitable tax deduction for Jane's gift. The steps are identified in Lines (A) through (H).

(A) To calculate the amount the annuity will pay Jane, the gift annuity value is multiplied by the annuity payout percentage. The annuity payout percentage of 7.7% is multiplied by the $100,000 gift, which produces an annual annuity payout of $7,700. This means that Jane will receive an annuity of $1,925 quarterly. The annuity payout amount is rounded up to the nearest two, four or twelve cents (depending on the type of payment chosen: semiannually, quarterly or monthly) in order to ensure that all payments are the same to the exact cent, thus simplifying administration. In Jane's case, there is no rounding necessary because the payments divide equally. The AFR for the current month or for either of the two prior months may be used to determine the charitable deduction under Sec. 7520. With an annuity, if the annuitant desires greater tax-free payments, the lowest AFR is preferable. If the donor wishes to have a larger charitable deduction, the greatest AFR is selected. Therefore, Jane's gift planner selects a 2.6% AFR.

(B) The next step is to calculate the Dx factor. The Dx factor for a single life can be found in Pub. 1457, Table H. The appropriate chart in Table H is the one corresponding to the 2.6% AFR. The annuitant's age is listed on the right hand side of the chart. The factor needs to be found for Jane's age at the first payment from the annuity, age 79 (7086.096813) and again for her age at the creation of the annuity, age 75 (9417.121863).

(C) Once the two Dx have been found, the factor for the age at the first payment must be divided by the factor for the annuitant's age at the annuity creation. The corresponding number is the useable Dx factor (7086.096813/9417.121863= 0.752469).

(D) The next step is to calculate the annuity factor. The annuity factor for a single life is determined using Pub. 1457, Table S. The appropriate chart in Table S is the one corresponding to the 2.6% AFR. Jane's age at the date of the first payment (79) must be found on the left side of the appropriate chart. The result is the unadjusted annuity factor. For Jane, the unadjusted annuity factor is 7.5469.

(E) An adjustment of the annuity factor is required if the payment frequency selected is anything other than annually. Because Jane selected quarterly payments, the time adjustment factor must be found in Pub. 1457, Table K. Locate the appropriate AFR (2.6%) at the left side of the table and the corresponding payment frequency (quarterly) along the top. Here, the time adjustment factor is 1.0097.

(F) The time adjustment factor is multiplied by the annuity factor to calculate the adjusted annuity factor. In the worksheet above, Line (D) is multiplied by Line (E). Jane's time adjustment factor of 1.0097 is multiplied by the annuity factor of 7.5469 to produce the adjusted annuity factor of 7.6201.

(G) This section is a determination of the deferred gift annuity rate. The factor is determined by multiplying the useable Dx factor of 0.752469 by the adjusted annuity factor of 7.6201. Line (C) is multiplied by Line (F) to produce the deferred gift annuity rate of 5.7339.

(H) Next, the present value of the annuity must be determined. The deferred gift annuity rate is multiplied by the annual annuity payout. Line (G) is multiplied by Line (A). The deferred gift annuity rate of 5.7339 is multiplied by the annual annuity payout of $7,700 to produce a present value of $44,151.03.

(I) The amount transferred is the amount of cash or the fair market value of the property used to fund the annuity. Here, Jane contributed $100,000.

(J) Finally, the $44,151.03 present value of the annuity is subtracted from the $100,000 transferred to produce the charitable gift value. Here, $100,000 less $44,151.03 produces a $55,848.97 charitable gift value.

Taxation of Annuity Payments
One of the major benefits of a charitable gift annuity is partly tax-free income. Lines (K) through (S) on the charitable deduction worksheet provide the method for determining the taxation of the annuity payments.

(K) The unadjusted expected return multiple is the next item calculated and may be found in Reg. 1.72-9, Table V. Jane's age at the date of the first payout (65) must be found on the left side of the chart. The multiple is shown on the same row. Jane's unadjusted expected return multiple is 10.0.

(L) If the annuity payments are to be made annually, semiannually or quarterly, an additional adjustment must be made. This adjustment can be found in Reg. 1.72-5(a)(2). By locating the number of whole months from the annuity starting date to the first payment date (12 or more), and following that column down to the row which shows the frequency under which payments are to be made (quarterly), the adjustment is -0.1.

(M) Lastly, the adjusted expected return multiple must be calculated in accordance with Sec. 72. The unadjusted expected return multiple (10.0) is added to the frequency adjustment (-0.1) to produce an adjusted expected return multiple of 9.9.

(N) The expected return is calculated by multiplying the adjusted expected return multiple of 10.0 by the annual annuity payout of $7,700. Thus, the expected return, or the amount that Jane can expect to receive over her life, is $76,230. However, since this is a term-of-years annuity, the lifetime payments are compressed into payments over only five years. The worksheet demonstrating the compressed payments is discussed at the end of the following section.

(O) The exclusion ratio demonstrates the amount of each annuity payment received which will be tax-free as a return of principal. To determine the exclusion ratio, the $44,151.03 present value of the annuity shown in Line (H) is divided by the $76,230.00 expected return shown in Line (N). Jane's exclusion ratio is therefore 57.9%. This means that 57.9% of each annuity payment Jane receives will be tax-free.

(P) Line (P) applies the exclusion ratio to the annuity payment to give the exact amount of each payment that will be excluded from ordinary taxation. The calculation is performed by multiplying the exclusion ratio of 57.9% by the annual annuity payment of $7,700 to produce $4,458.30. This means that $4,458.30 of the $7,700 Jane receives annually will be tax-free.

(Q) Jane's basis in the contributed property is $100,000 because she made a gift of $100,000 cash. The basis of $100,000 is multiplied by the present value of the annuity shown in Line (H), or $44,151.03 then divided by the amount of the gift or $100,000. This formula produces a result of $44,151.03, which will be the amount of the $100,000 basis that will be allocated to the annuity. The tax-free payments over the life of the annuitant will be $44,151.03.

(R) The third potential component of each payment is gain. The gain allocated to the annuity is calculated by subtracting the basis allocated to the annuity (Line (Q)) from the present value of the annuity (Line (H)). The gain allocated to annuity is the present value of the annuity of $44,151.03 less Jane's basis allocated to the annuity of $44,151.03. In other words, Jane has no gain to allocate to the annuity because she made a cash gift in return for the annuity. If Jane had given appreciated property in return for the annuity, she would have gain that could be allocated to the annuity.

(S) The gain each year can be computed by dividing the gain allocated to the annuity (Line (R) by the adjusted expected return multiple (Line (M)). In this case, the formula would be 0 divided by 9.9, giving Jane a gain each year of 0. This amount should never exceed the amount excluded from ordinary income (Line (P)).

Term-of-Years Annuity Option Worksheet
The worksheet below demonstrates the compressed payout schedule.

           
TERM OF YEARS ANNUITY OPTION
Funding in 2018 at Age 75   Value in 2022 at Age 79  
  Gift Annuity: $100,000.00   Annuity Value: $58,674.77  
  Char. Gift: $55,848.97   Life Annuity: $7,700.00  
  Ann. Value: $44,151.03   5 Year Ann. $12,544.32  
 Option: Elect Five Year Annuity of $18,761.48 Before March 31, 2008 (See Sec. 72(e)(2)(A))
  Annuitant: Jane Donor Birth Date: 06/01/1943  
  Pmt. Freq.: Quarterly First Pmt. Date: 01/01/2023  

       
(A) Annual Life Annuity Payout: $7,700.00 (A) 
      AFR of the Month 2.6%    
(B) Factor:                  Age 79 7.5469 (B) 
      (IRS Pub. 1457, Table S)    
(C) Adjusted Factor: 1.0097 7.6201 (C) 
      (Using IRS Tables of gift date)    
(D) Value of Annuity in 2022: $58,674.77 (D) 
      (IRS Pub 1457, Table B * Adjusted)    
(E) Adjusted Factor - Five Years: 4.6774 (E) 
      (IRS Pub. 1457, Table B* Adjusted)    
(F) Five Year Annuity Amount: $12,544.32 (F) 
      (See PLR 9042043, PLR 9407008)    

         
INCOME TAXATION
    Tax Analysis: Annual      Cumulative   
Ann. $12,544.32 Ordinary $3,714.11 $18,570.57 
Tot. Ret. 62,721.80 Basis 8,830.21 44,151.03 
Year Ordinary
Income		 Capital
Gain Payout		 Tax-Free
Return		 Cumulative
Capital Gain		 Cumulative
Tax-Free
2013 $3,714.11 $0.00 $8,830.21 $0.00 $8,830.21
2014 3,714.11 0.00 8,830.21 0.00 17,660.42
2015 3,714.11 0.00 8,830.21 0.00 26,490.63
2016 3,714.11 0.00 8,830.21 0.00 35,320.84
2017 3,714.13 0.00 8,830.19 0.00 44,151.03
2018 0.00 0.00 0.00 0.00 44,151.03
2019 0.00 0.00 0.00 0.00 44,151.03
2020 0.00 0.00 0.00 0.00 44,151.03
2021 0.00 0.00 0.00 0.00 44,151.03
2022 0.00 0.00 0.00 0.00 44,151.03
2023 0.00 0.00 0.00 0.00 44,151.03
2024 0.00 0.00 0.00 0.00 44,151.03
2025 0.00 0.00 0.00 0.00 44,151.03
2026 0.00 0.00 0.00 0.00 44,151.03
2027 0.00 0.00 0.00 0.00 44,151.03
2028 0.00 0.00 0.00 0.00 44,151.03
2029 0.00 0.00 0.00 0.00 44,151.03
2030 0.00 0.00 0.00 0.00 44,151.03
2031 0.00 0.00 0.00 0.00 44,151.03
2032 0.00 0.00 0.00 0.00 44,151.03
2033 0.00 0.00 0.00 0.00 44,151.03


The term-of-years annuity option worksheet provides information about the annuity and the calculations used to compress the annuity payments from Jane's life to a period of five years. The first box delineates Jane's age, the gift amount, the present value of the annuity, the value of the annuity in 2013, the annuity payout over Jane's life and the five-year term-of-years annuity payment.

The second box provides the steps taken to determine the compressed annuity payment. The steps are identified in Lines (A) through (F).

(A) The annual life annuity payout is pulled from Line (A) of the above charitable deduction worksheet and is $7,700. The 2.6% AFR the gift planner selected is also shown.

(B) The unadjusted annuity factor of 7.5469 also is taken from the worksheet above, from Line (D).

(C) The adjusted factor is then calculated by multiplying the unadjusted annuity factor of 7.5469 by the time adjustment factor calculated on the charitable deduction worksheet above in Line (E). Thus, 7.5469 multiplied by the time adjustment factor of 1.0097 is 7.6201.

(D) The above steps are used to calculate the value of the annuity in 2023. The value of the annuity will be $58,674.77 in 2023.

(E) Next, the adjusted factor must be calculated using Pub. 1457, Table B. Using the 2.6% AFR as the interest rate, locate the appropriate chart in Table B. Because the annuity will pay out over five years, find five years in the column at the left. The corresponding number is from the table is 4.6774.

(F) The five year annuity amount, or the amount the annuity will pay each year for five years, is calculated by dividing the value of the annuity in 2023 by the B factor. Therefore, the amount Jane will be paid each year for five years is $58,674.77 divided by 4.6774, or $12,544.32.

Related Topics on Term-of-Years Annuity

6.3.2  Deferred Gift Annuity:    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.

6.3.4  Flexible Deferred Gift Annuity:    In PLR 9743054, the Service approved the use of a flexible deferred gift annuity. A flexible deferred annuity allows a donor to select a target date and when the annuity payments will begin.

      Quiz-Basic



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