It was Will Rogers who once said, "I'm not as interested in return on my principal as I am return of my principal. In this case study, Mr. Braun, an 82-year-old widower who is worried about market volatility, learns how he can transfer appreciated stock from his portfolio to a charity in exchange for a charitable gift annuity that will provide him with a substantial income tax deduction and fixed annual payments that will provide for his future health care and other needs for the balance of his life. In addition, Mr. Braun will make a meaningful contribution to his community.

The Facts

Mr. Braun is a widower age 82.  He was an early investor in a very successful company.  His stock has been worth as much as $1.5 million and is now worth over $1 million.  It pays very low dividends, currently less than 1%.  He vividly remembers a number of past market downturns and is concerned that current market conditions may result in further losses over time that he is not prepared to sustain.  He does not believe his current position will fare well in a market correction and would like to sell the stock and put the proceeds in cash and debt instruments.  He would like more income as he anticipates very heavy cash outlays for health care as he grows older.

The Problem

His basis in the stock is just $150,000.  Even after reductions in capital gains tax rates in recent years, he would still owe $127,500 in capital gains taxes on a sale of the stock, leaving him just $872,500 to reinvest for income in the range of 4% per year.  He is in a combined 35% state and local tax bracket, so he would pay some $12,215 in income taxes on income of $34,900 and be left with $22,685 in spendable income.  He does not like this scenario.

Mr. Braun was born in 1927, and he remembers hard economic times when he was growing up during the Depression.  Even though he knows he might be able to earn more through more aggressive investments, he does not believe the markets will continue to perform in the same manner as they have over the past twenty years, and he is not comfortable with what he considers to be a relatively high level of risk.

Because of these concerns, he is considering a sale of the securities regardless of the relatively small amount of income he will enjoy from the net proceeds.

The Solution

He receives information from one of his charitable interests that points out that for a gift of (1) $1,000,000 he would receive payments of (2) 7.4%, or $74,000 per year from a charitable gift annuity.

Mr. Braun is intrigued to learn that he would be entitled to an income tax deduction of some (3) $431,950 in the year of his gift. His accountant tells him that he could not fully utilize this benefit immediately due to the 30% limitation of AGI rule for gifts of appreciated property, but that he may carryover the deduction for an additional five years.  Mr. Braun is still very pleased because he knows that in addition to an increased life income, he has made a (4) significant charitable gift.

He and his accountant are much more interested in the way in which his gift annuity payments would be taxed. Gift annuity payments where gift annuities are funded with appreciated property are taxed very favorably.  A portion of each payment is taxed as ordinary income.  Over the period of time equal to the life expectancy of the payment recipient in the case of a single donor, the portion of the payment that is considered return of the donor's "investment in the contract" is partially taxed as capital gain income and the remainder is received free of tax.  The capital gain attributed to the gift portion of the annuity is never taxed.

Given the fact that the portion of his gift annuity payments attributable to the gain in the property used to fund his gift annuity would be taxed at a maximum rate of 15%, the $74,000 he would receive each year would be taxed as follows for the first ten years he receives his payments (his life expectancy).  Thereafter the entire amount would be taxable as ordinary income.

The Comparison

Mr. Braun would have to earn nearly 11% on the net proceeds of the sale of his securities under the above assumptions to enjoy the same after-tax income for the first decade following his gift. 

For the reasons outlined above, lower interest rates, equity market volatility, and lower capital gains taxes combine to make gift annuities more attractive to certain donors.

Disclaimer: This case study is intended to provide information of a general nature only and is not intended to provide legal, accounting, investment or other professional advice. Persons mentioned within this case study are fictional with any resemblance to real persons, living or dead, coincidental. Tax law rates, federal discount rates, and gift annuity rates used in examples are based on those rates in effect at the time of publishing. Those viewing this case study should always check for latest tax and other relevant state and federal laws and regulations prior to completing charitable gifts.