Life Expectancy and Gift Planning: It's Not What You Think

 

70-years-old-candles.jpgA 70 year-old wants to fund a 5% charitable remainder unitrust with $500,000. If he receives payments for the rest of his life, he gets a charitable deduction of $261,815. On the other hand, if he chooses to receive payments for exactly his life expectancy of 14.2 years, he gets a deduction of $244,060. Strange. Why aren’t the two numbers the same?

What Is Life Expectancy?

What do I mean when I say someone has a life expectancy of 14.2 years? I mean this: that the person has an equal likelihood of living less than 14.2 years and more than 14.2 years. Put another way, half of the people the person’s age live less than 14.2 years and the other half live longer than 14.2 years. Only a tiny fraction of them will live exactly 14.2 years. The rest will live anywhere from less than 1 more year to 40 more years. Why won’t any 70 year-olds live more than 40 years? Because the 2000CM mortality table (Table 2000CM), the table used to compute charitable deductions for planned gifts, predicts that no one lives beyond 110.

What Is Mortality?

I just mentioned the 2000CM mortality table, but what is it? Table 2000CM is based on data from the 2000 U.S. Census and shows how many people out of an original population of 100,000 are alive at each age from 1 to 110. For example, 74,794 of the original 100,000 are alive at age 70. At age 71, 73,001 are still alive. So, according to Table 2000CM, the probability that someone who is 70 will live to be 71 is 73,001/74,794, or 97.6%.  At age 72, 71,092 are still alive, so the probability that someone who is 70 will live to be 72 is 71,092/74,794, or 95.1%. In short, mortality is the likelihood that someone of a certain age will live to achieve each subsequent age.

Computing the Charitable Deduction for a Planned Gift

When your planned giving software computes the deduction for a gift annuity, charitable remainder unitrust, or other split interest gift that will last for the lifetime of the income beneficiary, it uses mortality, not life expectancy. For each age beyond the beneficiary’s current age, it uses Table 2000CM to determine the likelihood the beneficiary will live to receive payments. It then multiplies that probability by the present value of receiving payments that year.  Add up all these results and you have the present value of the lifetime of payments. Subtract that sum from the funding amount and you have the charitable deduction. There are adjustments for payment frequency and timing, but that’s the gist of it.

Contrast the above with what happens when your planned giving software computes the deduction for a life income gift that will last for an exact number of years, such as 14.2. In this case, there is no possibility that the gift term will last less than or more than the stated number of years. Probability drops out of the calculation. Your software simply determines the present value of receiving each year’s payments through the final year of the gift, then adds up all the results to determine the present value of all the payments together.  Once again, subtract that sum from the funding amount and you have the charitable deduction.

Now that we’ve worked through the logic of computing the value of payments for life versus payments for a life expectancy, it should no longer be surprising that the deduction for a CRUT that will last for the beneficiary’s life differs from the deduction for a CRUT that will last for the beneficiary’s life expectancy.

The One Place Life Expectancy Comes into Play

There is one planned gift calculation where life expectancy rather than mortality is used: the taxation of gift annuity payments. The number of years that a gift annuitant will receive payments that are partially tax-free equals the annuitant’s life expectancy. The life expectancy is computed using the 1983 Basic mortality table (yes, there are many mortality tables). For example, according to this table, a 70 year-old has a life expectancy of 15.9 years, so a 70 year-old gift annuity donor will receive partially tax-free payments for 15.9 years. The table actually shows a 70 year-old has a life expectancy of 16.0 years, but there’s a slight adjustment for payment frequency, so a quarterly paying annuity will be partially tax-free for 15.9 years. In most cases, any capital gain portion is also reportable for the annuitant’s life expectancy.