Charitable Gift Annuities for Domestic Help

When we think of income beneficiaries for charitable gift annuities, most of us picture a donor or a donor and his or her spouse, and these are indeed the most common cases. Yet the donor can name anyone who meets the issuing organization’s minimum age requirement as the income beneficiary. Gift annuities can offer an opportunity for kind-hearted individuals to care for others who need additional cash flow by providing a secure source of payments.

Providing retirement cash flow for a domestic worker

Before Mr. Gregory’s mother passed away some time ago, she made him promise to provide for her longtime home aide, housekeeper and companion, Mrs. Packard, as a reward for her many years of faithful service. Mr. Gregory, age 55, a single man, has been helping to support Mrs. Packard, now 80, ever since with income of $500 per month. Since he is in a 39.6% federal tax bracket, it takes quite a lot of pre-tax earnings to pay her the $500 per month he has been providing. He wonders whether there is a way that he could simultaneously make a gift to his favorite charity and provide for Mrs. Packard more tax-efficiently. He also thinks he should reduce his holding in a particular low-yielding stock. The market value of his shares is $300,000, and his cost basis is $70,000. The stock is paying a dividend of 2%.

The problem

Mr. Gregory has multiple objectives and multiple problems. He wants to support Mrs. Packard and to make a charitable gift. Because of his 39.6% income tax rate, he must earn $828 a month to provide Mrs. Packard with $500 on an after tax basis. At his 23.8% capital gains rate, selling and reinvesting the proceeds from his stock would generate a capital gain tax of $54,740. He only receives $6,000 income from the stock which translates to $4,572 after tax, assuming the stock pays qualified dividends.

The solution

Mr. Gregory could fund a charitable gift annuity with his stock for the benefit of Mrs. Packard that would pay her an annuity of 6.8% or $20,400 per year!

In so doing, he would be making a taxable gift to Mrs. Packard equal to the present value of her payments. Assuming a federal discount rate of 1.4% and payments made at the end of each month, the present value of those payments is the difference between the $300,000 value of the stock and the $141,744 income tax charitable deduction, for a total taxable gift of $158,256. Mr. Gregory could offset the gift with his available gift tax exemption or retain the right to revoke Mrs. Packard’s annuity payments. If he retained that right, then because her annuity of $20,400 exceeds the current gift tax annual exclusion of $14,000, he would have to file a gift tax return each year. So long as any of his gift tax exemption remains available, however, there would be no net gift tax due.

Also, since the annuity is paid to someone other than the donor, a portion of the capital gain ($121,330) is taxable in the year of the gift. Nevertheless, this amount will be more than offset by his income tax charitable deduction of $141,744. Problem solved!

Other situations that may spark interest among potential donors

The tax consequences and benefits described above would apply to an annuity for any beneficiary who is not the donor or the spouse (as recognized for federal tax purposes). Your potential donors could establish similar annuities for aging parents, a sibling who is struggling financially, or a friend.

Somewhat different considerations apply in the case of an employer that wants to establish a gift annuity for the benefit of an employee. If an employer sets up an annuity for the benefit of the employee, in the year the annuity is funded, the employee will have taxable income equal to the present value of the payments. That taxable income is equal to the gift principal minus the income tax charitable deduction as in the gift tax example above.  This could create a cash flow problem for the employee. If the employer were to reserve the right, exercisable anytime, to revoke the employee’s payments, the employee would include in taxable income only the amount actually received year by year.