Charitable Gift Annuities: Smart Way to Income and Tax Savings?

It seems designed to be as confusing as possible.

Yeah, I’m talking about the U.S. tax code, with its 10,000+ sections, and 6,980 pages. Adding all the regulations, interpretations, and official tax-law guidance, you get to ~75,000 pages!

But do you know what that means?

Nearly endless opportunities to reduce your taxes, and some can even benefit good causes.

How Smart Money Makes the Most of Giving

If you’ve been paying any attention, you know you can deduct charitable donations (cash and non-cash) from your taxable income.

That’s why Goodwill gets so busy as December 31^st rolls around.

It’s also how so many churches, synagogues, and mosques can afford their sizable buildings – congregants get to deduct their dues and other contributions.

But that’s just the tip of the tax-benefit iceberg.

Accountants and financial advisors of the “Smart Money” have some pretty hard-to-believe ideas on saving their clients tens of thousands, hundreds of thousands, even millions of dollars in taxes. 

Even better, instead of “tax avoidance,” they get labeled “philanthropy”!

To learn a little about this complicated topic, I reached out to Jacob T. Rothman, CPA, CFA, CFP®, Portfolio Manager, Rothman Investment Management. 

The following is based on our conversation (with a bit of my own research thrown in, so any errors are most likely mine).

How to Take Advantage Even if You’re not a Gazillionaire, Especially Following SECURE 2.0

Signed by President Biden as part of a $1.7 trillion omnibus law, the Setting Every Community Up for Retirement Enhancement (SECURE) 2.0 Act has lots of new and interesting provisions.

Among these is the one that offers a one-year exception allowing taxpayers to fund a charitable gift annuity (CGA) or Charitable Remainder Trust (CRT) through a Qualified Charitable Distribution (QCD) from an Individual Retirement Account (IRA). 

While there are some differences between a CGA and a CRT, for our purpose here, they work the same, so for simplicity, we’ll just refer to a CGA. In both, you make a split gift donation, retaining an income stream for the rest of your life and leaving the remainder to a charity.

Here’s why the new provision is especially interesting.

• A QCD from your IRA isn’t taxable 
• Funding a CGA through a QCD counts toward your Required Minimum Distribution (RMD).

Combine these two, and you realize that this new provision lets you reduce your taxable income and, thus, your taxes even more than simply making a charitable donation.

Note that this isn’t an open-ended, unlimited opportunity.

• You can add multiple gifts to the CGA under this provision, but only if all are within the same year
• You can contribute up to $50,000 per person ($100,000 for a couple, and nobody else can contribute)
• You can’t mingle non-QCD gifts into the same CGA
• The CGA must pay out at least 5% annually to the income beneficiary
• Payments must start within one year
• Annual payments from the CGA are fully taxable as ordinary income

An Example of the Best Use of This Idea

When you’re still in your seventies, RMDs are under 5% of your tax-deferred balance.

However, as you get older, the fraction of your balance you need to distribute grows. Once you’re 81 or older, it grows beyond 5%, which is the minimum annual CGA benefit. 

This means the best use is once you’re older. 

Things get even better if you happen to have a large RMD while also being temporarily in a high tax bracket. 

Here’s an example using a hypothetical couple, call them Jack and Jane.

Jack and Jane are both 85 and married, live in California, and file their taxes jointly. They have $1.6 million in traditional IRAs and 401(k) plans between the two of them. 

Because their RMD factor is 16, their RMD is $100,000. 

They also have $40,000 in taxable Social Security benefits, and their taxable accounts generate qualified dividends and long-term capital gains averaging $40,000 per year.

This places their annual income around $180,000, which with their deductions, places them in the 22% marginal Federal tax bracket.

This year, however, they sold their home, generating a long-term capital gain of $200,000 above their exemption, and sold long-term investments, realizing another $120,000 in income taxed at long-term capital gains rates.

Without a QCD, they’d be in the 35% marginal Federal income tax bracket (for 2022 taxes), 9.3% California bracket, and 15% capital gains bracket, plus be subject to the Net Investment tax of 3.8% on most of their capital gains. 

They’d also be subject to $8,000 in higher Medicare premiums in two years.

They use their one-time SECURE-2.0 exemption to contribute a total of $100,000 to a CGA. Doing this provides the following tax and premium savings:

• Reduces the amount taxable at the federal level (a mix of 35% and 32% brackets), saving $32,880
• Reduces the amount taxable at the state level (at the 9.3% rate), saving $9,300
• Avoids extra Medicare premiums, saving $8,000
• Eliminates the Net Investment Tax on that $100,000, saving $3,800

Altogether, they save about $54,000 in reduced taxes and Medicare premiums, equivalent to an effective total tax rate of 54%!

In addition, they can expect about $5,000 annual income for life. While that income is taxable, at their regular annual income levels, this extra $5,000 would be subject to about 31.3% combined Federal and state income taxes.

With a joint life expectancy of about 11 years, they can expect a $55,000 pre-tax income or about $38,000 after tax. That means they’re making a $100,000 donation at an after-tax cost of just $8,000!

If at least one of them lives just a few years longer, they’d end up making after-tax money from their charitable gift!

To CRT or to CGA?

The CGA and the Charitable Remainder Trust (CRT) are two tax-advantaged ways to give to charity.

The CRT also comes in two “flavors” – a Charitable Remainder Annuity Trust (CRAT), which is very similar to a CGA in that you get a set dollar amount each year (until and unless the trust runs out of money), which gives you predictability. 

This places the investment risk on the trust, but with the drawback that inflation eats away at the value of your income.

With the other CRT flavor, the Charitable Remainder UniTrust (CRUT), you get a fixed percentage of the trust asset value, which places the investment risk on you since if the trust’s assets lose value, your income drops. Of course, if the trust does well, your income grows.

In general, CRT trustees have more flexibility in setting the payout ratio and can manage the investments subject to fiduciary standards. This increased flexibility of a CRT may increase the cost to set up and run the trust, which makes it less plausible for smaller gifts.

The Bottom Line

It’s really hard to make money from giving money, but given the right circumstances, the tax code makes it possible (if super complicated!).

Not everyone can benefit, and you’ll most likely need the help of some really sharp financial advisors and/or accountants, but in those above mentioned right circumstances, you can have your philanthropic pie while also eating it.  

Disclaimer: This article is intended for informational purposes only, and should not be considered financial advice. You should consult a financial professional before making any major financial decisions.

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Disclaimer: This article is intended for informational purposes only, and should not be considered financial advice. You should consult a financial professional before making any major financial decisions.