Exchanging One Life Income Gift for Another
It is not unusual that a charitable remainder unitrust (CRUT) or pooled income fund (PIF) gift made by a donor years ago no longer meets the donor’s or charity’s financial objectives. A trust donor may fear that a stock market correction will deflate trust assets and her income. Or a trust with a high payout rate may be headed toward trust assets exhausting. A charity’s pooled income fund may have only a few remaining participants and the charity desires to terminate the fund because of excessive fees.
Exchanging a CRUT or PIF for a CGA
The “replacement” life income gift offered to donors in the above situations is almost always the charitable gift annuity (CGA). Essentially, the donor is exchanging the uncertainty of future payments for the trustworthy fixed payments of a charitable gift annuity. The question then becomes how to calculate the gift amount that will be exchanged into the charitable gift annuity.
What Does the Donor Have to Give?
The key point to remember is that all the donor must give is the present value of the remaining income payments of their current life income gift. It is sometimes thought, incorrectly, that all the assets of the charitable remainder trust or the principal in the pooled income fund belong to the donor and that is the amount used to calculate the payments for the charitable gift annuity. This is not the case. The CRUT or PIF income beneficiary owns the right to future income, but the present value of the rest of the principal belongs to the charity. Two examples should help to clarify the issue.
Exchanging a CRUT for a CGA
In the mid 90’s when interest rates were high a donor funded a 10% standard CRUT with $1,000,000. The current value of trust assets is $650,000. The donor, now 75, is concerned because the CRUT assets are decreasing as are her annual payments. The present value of the donor’s life income interest is $395,369 ($650,000; May 2019 CMFR of 2.8%; age 75). The ACGA suggested rate for a donor age 75 is 6.2%. By exchanging her life income interest in the CRUT for a CGA the donor will receive annual annuity payments of $24,512.88, far less than what she is currently receiving from the CRUT.
Exchanging a PIF interest for a CGA
The calculation to determine the present value of the life income interest in a pooled income fund is like the CRUT calculation, except instead of the IRS discount rate the calculation uses the highest rate of return for the PIF for the last three years. For example, a donor is 80 and if the charity were to sever the donor’s interest in the assets in the fund the amount would be $50,000. The highest rate of return of the fund over the last three years is 2.5%. The present value of the donor’s life income interest is only $9,018. That is the amount the donor must contribute in exchange for a charitable gift annuity. The suggested ACGA rate for an 80-year-old is 7.3% and the annual annuity income will be $658.32, less than the donor is receiving from the PIF.
Anticipating the Donor's Objections
To make the exchange more palatable to the donor/income beneficiary recognizing that she will likely be receiving substantially lower income from the CGA, a charity may choose to transfer the entire principal balance in the CRT or PIF to their CGA reserve fund and to increase the annual annuity payment to something more acceptable to the CGA beneficiary. However, this raises numerous issues such as compliance with state regulations if in a regulated state, ACGA rate conformity if the charity follows ACGA rates, and ensuring that the charitable deduction for the new CGA meets the IRS 10% rule. These issues will likely require the expertise of an individual familiar with all the intricacies and legalities of a charitable gift annuity, including state regulations.
When exchanging a donor’s interest in a CRUT or PIF for a CGA, the donor only has the present value of their life income interest as the funding asset for the new life income gift (i.e. CGA). Of course, a philanthropically minded donor who doesn’t need the income might decide to contribute their remaining income interest to your charity. Whether exchanging the present value of income payments from one life income gift for another, or donating the life income interest outright to your charity, the donor will likely require a qualified appraisal to substantiate their charitable deduction for the new gift, and also IRS Form 8283 to be filed with their income tax return.