Thursday April 25, 2024

6.3.4 Flexible Deferred Gift Annuity

Flexible Deferred Gift 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.
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 of when the annuity payments will begin. However, the annuity contract permits a donor to take the annuity earlier or later than the target date. Because the charitable deduction is based on the target date, if the donor decides to start the annuity earlier, the annuity payout will be reduced to a level that produces the same charitable deduction as the target date. Some flexible deferred annuity donors may choose to take the reduced rate at an earlier time. Others may decide that they do not need income and may choose a later starting date with a higher payout. Finally, some donors may not require any income upon retiring, and thus, may choose to donate the contract to the issuing charity and receive an additional charitable deduction in the year the contract is donated. A flexible annuity must have a deferral period of at least one year from the date of creation. In addition, the starting date of a flexible deferred gift annuity must be one full period prior to the issuance of the first annuity payment. 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 the first payment. Reg. 1.72(4)(b)(1)(ii). After the annuity starting date, the annuity is treated the same as a current annuity.

Because there is a deferral period between the funding date and the annuity starting date, a deferred annuity pays a higher rate. The charity holds and invests the transferred funds during the deferral period. Because the charity has a reserve earning income, a higher rate is possible based on the potential growth. A long deferral period can increase the rate substantially. However, given the potential earnings of the charity, the payout on the probable future annuity reserve will typically be less than a current annuity funded at the same 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 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 deferred charitable gift annuity on June 1, 2017 with a target date of June 1, 2022. Jane is 74 years old. The fair market value of the property used to fund the annuity is $100,000. Jane's annuity has a payout rate of 7.7%. The AFR for the month of June is 2.4% 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: 6/1/2017  
  1st Person: Jane Donor Birth Date: 06/01/1945  Pay Date: 06/01/2022  
  Cost Basis:         $100,000.00 IRS Ann. Starting Date:   03/01/2022  
  Payment Freq.:   Quarterly             (Payments at End of Selected Period) Annuity % 7.7  
 
     
 (A) Annual Payout: $7,700.00 (A) 
       Gift Amt. x Annuity %
       AFR of the Month:   2.4		    
 (B) D Factor:    
       Age:   79 8267.077487 (B) 
       Age:   74 11564.116552 (B) 
       (IRS Pub. 1457, Table H)    
   
 (C) D Factor/D Factor: 0.714891 (C) 
 (D) Unadjusted Value $1, Ann. Start Age: 7.6398 (D) 
       (IRS Pub. 1457, Table S)    
 (E) Adjustment for Time of Payment: 1.0090 (E) 
      (IRS Pub. 1457, Table K)    
 (F) Adjusted Factor: 7.7086 (F) 
       Line(D) x Line(E)    
 (G) Value $1 of Deferred Annuity: 5.5108 (G) 
       Line(C) x Line(F)    
 (H) Present Value of Annuity: $42,433.16 (H) 
       Line(G) x Line(A)    
 (I) Amount Transferred: $100,000.00 (I) 
 (J) CHARITABLE GIFT VALUE $57,566.84 (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 55.7% (O) 
       Line (H) Divided By Line (N)
 (P) Amt. Excluded From Ordinary Taxation $4,288.90 (P) 
       Exclusion Ratio Times Annuity
       (I.R.C. Sec. 72(b)(3))
 (Q) Basis Allocated to Annuity $42,433.16 (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 6/1/2017 Initial Age 74
  Date of First Payment 6/1/2022 Start Age 78
      Payment Age 79
  Amount Transferred   $100,000.00    
  Annual Payment   $7,700.00    
  Char. Deduction   $57,566.84    
     EXCLUSION RATIO UNTIL 2031  55.7%  
      (If current IRS Tables effective)    


The upper section lists Jane's name, birth date, gift date and date of first annuity payment. The date of first annuity payment must be within the first period under the payment frequency. Since this annuity pays quarterly, the date of first payment must be within three months of the funding date.

Lines (A) through (J) are used to determine the charitable deduction.

(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 annuity payout of $7,700. This means that Jane will receive a payment of $1,925 quarterly. The annuity payout amount is rounded up to the nearest two, four or 12 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, no rounding is necessary because the payments divide equally. The AFR for the month of the gift 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. Therefore, Jane's gift planner selects a 2.4% AFR.

(B) The next step is to calculate the Dx factor. The Dx factor is found in Pub. 1457, Table H. Locate the chart that has the correct AFR at the top. The annuitant's age is listed on the right side of the chart. The factor needs to be found for Jane's age at the estimated first payment from the annuity (79) and again for Jane's age at the creation of the annuity (74). The respective factors are 8267.7077487 and 11564.116552.

(C) Once the two Dx factors have been found, the factor for Jane's age at the estimated first payment (79) is to be divided by the factor for Jane's age at the annuity creation (74). The corresponding number is the usable Dx factor (8267.077487/11564.116552=0.714891).

(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 2.4% 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 7.6398. In contrast, to find the annuity factor for a two-life annuity trust, Pub. 1457, Table R(2) is used. The appropriate chart in Table R(2) is the one corresponding to the chosen AFR. The beneficiaries' ages at the date of the first payment must be found on the left side of the appropriate chart. The result is the unadjusted annuity factor. Once the factor is found, subtract it from 1 and divide the result by the selected AFR. The product of the formula is the unadjusted annuity factor for two lives

(E) The next step is to determine the time adjustment factor. Because Jane selected quarterly payments, the factor is 1.0178. The time adjustment factor is found in Pub. 1457, Table K by locating the appropriate AFR (2.4%) at the left side of the table and using the corresponding payment frequency (quarterly).

(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 1.0090 is multiplied by the annuity factor of 7.6398 to produce the adjusted annuity factor of 7.7086.

(G) This section is a determination of the deferred gift annuity rate. The factor is determined by multiplying the usable Dx factor of 0.714891 by the adjusted annuity factor of 7.7086. Line (C) is multiplied by Line (F) to produce the deferred gift annuity rate of 5.5108.

(H) Once the adjusted annuity factor is calculated, the present value of the annuity must be determined. The fair market value of the property transferred to the annuity is multiplied by the adjusted annuity factor. Line (G) is multiplied by Line (A). The adjusted annuity factor of 5.5108 is multiplied by the annual payout of $7,700 to produce a present value of $42,433.16.

(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 $42,433.16 present value of the annuity is subtracted from the $100,000 transferred to produce the charitable gift value. Here, $100,000 less $42,433.16 produces a $57,566.84 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 (79) 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 found to be -0.1.

(M) 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 9.9 by the annual payout of $7,700. Thus, the expected return, or the amount that Jane can expect to receive over her life, is $76,230.

(O) The exclusion ratio demonstrates the amount of each annuity payment received that will not be taxed as ordinary income. To determine the exclusion ratio, the $42,433.16 present value of the annuity shown in Line (H) is divided by the $76,230 expected return shown in Line (N). Jane's exclusion ratio is therefore 57.7%. This means that 57.7% 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 57.7% by the annual payout of $7,700 to produce $4,288.90. This means that $4,288.90 of the $7,700 in payments 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 $42,433.16, then divided by the amount of the gift, or $100,000. This formula produces a result of $42,433.16, which will be the amount of the $100,000 basis that will be allocated to the annuity. Jane will receive $42,433.16 of tax-free payments if she lives her full life expectancy.

(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 the annuity is the present value of the annuity of $42,433.16 less Jane's basis allocated to the annuity of $42,433.16. 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)).

Private Letter Rulings

PLR 200449033 IRS Approves "Flexible" Deferred Charitable Gift Annuity:   Chesapeake Charity ("Charity") offers gift annuities to its donors. Charity proposes to offer a "flexible" deferred charitable gift annuity to Doug Donor ("Donor"). Under the proposed annuity, Donor will transfer cash or property to Charity in exchange for Charity's promise to make fixed payments to Donor over his lifetime. The beginning date of the fixed payments would be deferred for at least one year.

PLR 9743054 Flexible Deferred Annuity:   Deferred annuities are merely annuity contracts in which the payment is deferred for one year or longer. However, many deferred annuitants would like a flexible choice of dates for starting the payment. The concept is relatively simple - the annuitant sets a preferred payout age, such as 65, and a printout is prepared for payout ages from perhaps age 60 to age 90. If the annuitant decides to take the payout earlier, he or she will receive a smaller payout. Conversely, by deciding to wait and take the payout at a later date, the donor will receive a larger annual payout amount.

Related Topics on Flexible Deferred Gift Annuity

3.3.8  Deduction for Unrecovered Basis:    Under the bargain sale rules, a transfer for a gift annuity produces a charitable deduction and a contract value retained by the donor. Reg. 1.1011-2(a). With a cash annuity, the contract value represents the donor's principal. This principal is returned on a prorated basis each year to the donor. Since it is a return of his or her principal, it is tax-free.

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.

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