Charitable Gift Annuity Tax Deduction

When you use a charitable gift annuity to make a donation, you can take an income tax deduction. Since you get annuity payments, your deduction is limited.

This post is provided for general information only. Please confirm the details and circumstances of your unique situation with your tax accountant or other appropriate advisor before taking action.

How does a charitable gift annuity work?

A charitable gift annuity is similar to an annuity that you might purchase through an investment company. You buy a gift annuity for a lump sum, and the charity makes annuity payments to you.

The gift is that the charity keeps the principal from your contribution. The charity expects its investment returns to be higher than what it has to pay you.

Most annuities last for life. Some start immediately, while others have a delayed start.

A common advantage to a delayed start is reducing your income taxes during your peak earning years while giving you higher income during retirement. For example, you might buy a charitable gift annuity when you’re 40 that begins making annuity payments when you turn 65.

Can you deduct a charitable gift annuity?

Charitable gift annuities are generally tax-deductible. They follow most of the charitable contribution deduction rules.

The catch is that you have to subtract the value of the gift annuity payments from your income tax charitable deduction. You usually do this by calculating the present value of your future payments.

Calculating the present value is somewhat complicated because it depends on your expected rate of return and your life expectancy. 

Here’s a rough example:

  • You have a charitable gift annuity that pays $500 per month based on a 5% rate of return.

  • You use the IRS life expectancy tables to determine that the IRS expects you, on average, to live another ten years.

  • Using a present value of an annuity calculator, you determine that the present value is $47,140.68.

  • You paid $100,000 for the annuity.

  • You can expect a tax deduction of $52,859.32 after subtracting the present value of the charitable gift annuity payments from what you paid for the gift annuity.

Again, this is only a ballpark example, and there are a few moving parts. Talk to a tax advisor to get a more precise estimate.

Can you convert appreciated securities into a charitable gift annuity?

You can generally convert appreciated securities into a charitable gift annuity. This will typically give you an immediate partial tax deduction for the market value of the securities adjusted for the present value of your lifetime income from the annuity.

Like with other donations of appreciated securities, you can also reduce your capital gains liability.

Normally, when you donate appreciated securities with unrealized capital gains, you can generally avoid paying any capital gains tax by donating the appreciated assets directly to a charity.

With charitable gift annuities, you can generally only exclude the part of the capital gain that went to charity. Again, you’ll need to calculate the present value of the annuity income you’ll receive.

Ballpark example:

  • You purchased a charitable gift annuity with $100,000 in appreciated stock.

  • You had $50,000 in unrealized capital gains.

  • You calculated that the income stream is worth 50% of what you paid for the annuity.

  • That lets you exclude $25,000 (50%) of your unrealized capital gains.

  • You’ll pay capital gains tax on the other $25,000.

Important: Since you may need to recognize capital gains when using appreciated assets to buy a charitable gift annuity, you need to consider your potential capital gains tax liability. Possible effects include moving to a higher capital gains tax bracket or increasing your Adjusted Gross Income high enough that you lose other tax benefits.

Do charities provide good estimates of your charitable tax deduction?

Many charities that offer charitable gift annuities provide examples of your potential tax deduction or even online calculators. These are often good estimates, but they may not match your final numbers.

You’ll also want to consider other tax implications, such as changes to your Adjusted Gross Income, income tax bracket, and capital gains tax bracket. You may want to talk to a tax accountant before making a final decision.

Is your charitable gift annuity income stream tax-free?

You’ll generally want to start with the assumption that your annuity payments will count as ordinary income for income tax purposes. Ordinary income is subject to federal income taxes and state income taxes.

A portion of your fixed payments may count as a tax-free return of principal in certain situations. Depending on how the money is invested, portions of your payments may be exempt from state and/or federal taxes.

You’ll need to get the specific details for each charitable gift annuity you’re considering. You should also find out if there’s a possibility that your income stream could change in a way that affects its taxability.

Again, you may want to talk to your tax accountant to help you evaluate potential charitable gift annuities.

How is a charitable gift annuity different from a charitable remainder trust?

With a charitable gift annuity, you pay the charity, and the charity makes payments to you.

With a charitable remainder trust, you set up a trust, and the trust pays you. The trust doesn’t pay the charity until the end. The charity gets the remainder of the trust.

As with a charitable gift annuity, charitable remainder trusts come with a partial tax deduction based on the expected value of what the charity will receive. Again, talk to your financial advisor for help calculating the exact differences in the tax benefits.

How is a charitable gift annuity different from a donor-advised fund?

In a donor-advised fund, you’re essentially setting up your own charity. Your entire contribution is generally eligible for a charitable deduction since you don’t receive payments from the donor-advised fund.

The money stays in your fund until you decide which charitable organizations you want your fund to donate to.

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