Which Is Better: Charitable Gift Annuity or Charitable Remainder Trust?

Charitable giving strategies can provide tax, estate planning, financial and other benefits. Maximize the benefits by selecting the strategy that’s best for you. The two main strategies to consider are the charitable gift annuity (CGA) and charitable remainder trust (CRT).

Each strategy offers a legacy because part of your wealth will benefit one or more charities you selected. You’ll also qualify for a current char- itable contribution income tax deduc- tion. You could wait to make a bequest through your estate, and the estate would qualify for a charitable deduction.

But with so few estates subject to the es- tate tax, there’s usually no tax benefit to waiting to give. Lifetime charitable gifts often provide more tax benefits. The strategies also provide a stream of income, though there can be differ- ences in the amount of income and its tax burden.

You can fund both strategies with either cash or the transfer of appreciat- ed investment assets. You’re likely to receive more benefits by using taxable appreciated long-term investments to fund a strategy. When you transfer appreciated investments to fund a CRT, you owe no tax on the gains at the time.

When appreciated investments are trans- ferred to a CGA, you might owe taxes on a portion of the gain at the time of the transfer. In either strategy, the charity or trust won’t owe taxes on the gains. It can sell the property and reinvest the full amount in diversified assets.

You’re only deferring capital gains taxes when appreciated property is used. As income payments are received each year, a portion will be taxed to you as part of your capital gain from the original property. The charity should send you a Form 1099-R each year listing the amount treated as capital gain. A CGA is a contract between you and a charity. The charity promises to pay you a fixed amount of income for life, no matter how long you live, or a fixed period of years, whichever you select at the start of the annuity.

You also can have a joint beneficiary, such as your spouse. Generally, the payments are fixed for life, but some charities offer “step annuities” in which the income payout increases each year. But the first year’s payout is lower than for a fixed annuity. The charity will tell you in advance the amount of the income payments. Most charities use the recommendations of the American Council on Gift Annuities of the maximum amount to pay.

The payout rate from the ACGA targets a gift to the charity in aggregate from its CGAs equal to 50% of the funds contributed to the annuity. The rate assumes the charity has a wide enough base of annuitants that the group has the average life expectancy. The ACGA also makes assumptions about average life expectancy, expenses and investment returns.

It assumes income payments are made quarterly. Though most charities follow the ACGA’s recommendation, some pay income at a lower rate. Some charities offer to adjust the pay- out so that a donor who doesn’t itemize expenses receives more income to com- pensate for the lack of a tax benefit.

Because most charities follow the ACGA recommendation, there’s usu- ally little benefit to shopping among charities for the highest payout. But you can compare a charity’s payout to the current recommendation on the ACGA website. Compare payouts of charitable gift annuities and commercial annuities to see how much income you give up each year to benefit the charity.

When you fund a CGA, the amount of your income tax deduction is determined using tables issued by the IRS that take into account your age, life expectancy and current interest rates. The older you are, the greater the income tax deduction.

In addition, if you die before receiv- ing income equal to your investment in the annuity, your estate can take an income tax deduction of the difference on your final income tax return. After entering into a CGA, you are a general creditor of the charity. There are no specific assets or insurance contracts you can recover if the charity misses payments. It’s important to check the financial condition of a charity before entering a CGA. After the Bernie Madoff scam was revealed, there were reports that several smaller charities defaulted on gift annu- ities because they invested large portions of their endowments with Madoff.

In a CRT, you set up a trust and con- tribute money or property. Most large charities will help set up the trust for little or no fee. Many charities also will administer the trust or serve as trust- ees at little or no cost. The trust will pay income over your choice of life (or the joint life of you and a beneficiary) or a period of years. You set the amount of income within limits established by the IRS that are designed to ensure the charity eventu- ally receives a minimum percentage of the initial contribution.

The income can be either a fixed annual amount or a percentage of the trust’s value at the end of the previous year. For both the CGA and CRT, the income will be a combination of return of principal (tax free), capital gains and other income. The CRT is backed by specific assets.

You aren’t a general creditor of the charity. But if the CRT’s investments don’t do well or you live a long time, the trust could run out of money. The CGA is easier to set up and maintain, but as I indicated, many charities try to limit the work and expense of a CRT. With a CRT, you might be able to change the ultimate charitable benefi- ciaries over time.

But the beneficiary of a CGA can’t be changed. Also, you might be able to set up the CRT so you control or influence the investments, but you can’t do that with a CGA. With a CGA, you can elect to defer the income for a few years after the contribu- tion, resulting in a higher payout. Some charities also offer a flexible deferred annuity in which the income starting date is left open until you select it. There’s a version of a CRT that allows income to be delayed for a period of years before income payments begin.

You can work with a charity and estate planner to set this up. CGAs also are not subject to self-deal- ing rules, but CRTs are. That allows certain flexible deals with a CGA. For example, you can donate an office building to a charity in return for a CGA but retain an office in the building. You also could donate stock in a family corporation in return for a CGA and later have another family member purchase the shares from the charity at fair market value. Neither action is possible with a CRT.