A Gift Annuity Is Not a Mortgage

We occasionally receive calls from clients regarding questions about the best way to perform internal accounting for charitable gift annuities. As a split-interest charitable gift arrangement, the CGA represents both a gift to the charity and a financial obligation to the annuitant(s). On this much, there is general consensus, but on the manner in which the charity should compute the estimated remaining liability for each CGA over time, there are two main approaches.

Given that the total funding minus the charitable deduction equals the total estimated liability at the outset of the gift arrangement, some organizations choose to record the incremental changes in liability as a sort of mortgage payment plan, or straight-line depreciation schedule. This method essentially amortizes the total estimated liability at the beginning and breaks that total down into regular and consistent annual amounts (sometimes even quarterly amounts).

There is a fundamental problem with this approach; A gift annuity is NOT a mortgage.

The mortgage payment schedule methodology starts with a total estimated liability and records payments that steadily decrease the liability over the life expectancy of the annuitant. This approach is premised on the concept that the liability can be paid down to zero, the way that a mortgage can be paid down to zero over many years. But the estimated remaining liability at the end of the originally projected life expectancy of the annuitant is not zero.

When an annuitant lives to the end of the originally projected life expectancy, in reality, that annuitant has an additional life expectancy. The tax-free income from a gift annuity may run out when the donor’s actual life exceeds the original life-expectancy estimate, but as we all know, the charity is under the obligation to continue making those annuity payments. Unlike the mortgage concept, the liability on a gift annuity does not end when the donor lives beyond the original estimate of her lifetime.

The second approach starts out the same, but then proceeds on a very different path; the remaining estimated liability is re-computed with each new year that the annuitant survives, based on changing estimates of remaining life expectancy. In fact, proper FASB accounting on financial statements of non-profits explicitly states this methodology in statements 116/117. This idea is in line with mortality tables, regardless of whether they are government tables or insurance industry tables.

For example, the remaining life expectancy of an 80-year-old female, based on the 2012 IAR table, is 12.9 years, but the remaining life expectancy for a 90-year-old female is 6.6 years. For every year that a person survives, their remaining life expectancy changes by less than one whole year. It may come as a surprise to learn that the remaining life expectancy for a female who is 100 years old is 3.1 years! The only point at which the estimated liability could “run out” is when the annuitant reaches 110 years of age, because that’s where the tables end.

We find that most organizations nowadays are going with this second approach, but some still do it as an amortization schedule, which does not accurately reflect the organization’s liabilities. Estimating remaining liability isn’t difficult, especially if you use GiftWrap. You’ll see that it practically never gets down to zero. FASB regulations allow you to choose which mortality table to use, and they give you latitude over the interest rate, but they don’t allow for treating gift annuities as mortgages to be paid off before or at the end of life expectancies. Proper liability reporting treats gift annuities as ongoing obligations with shrinking, but not vanishing, liabilities.