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Wednesday August 24, 2016

Article of the Month

Avoiding the "Missing Annuitant" Problem, Part I

Introduction


Charitable gift annuities (CGAs) can provide reliable, fixed payments for the beneficiary (often referred to as an annuitant). A CGA is typically established to make payments to a single annuitant for life or two annuitants over their joint lives. Payments are made by the charity that issued the charitable gift annuity in accordance with the payment timing and frequency spelled out in the annuity contract.

Periodically, however, an annuitant will have a change in address or a change in circumstances that interferes with the ability of the charity to deliver future payments. This gives rise to the “missing annuitant” problem that occurs after a charity has mailed several annuity payments that have been returned as undeliverable. When encountered with this situation, the charity will attempt to locate the annuitant, but those efforts may prove unsuccessful.

This month’s article, which is part one of a two-part series, will provide background information about charitable gift annuities and explain some of the events that can result in a missing annuitant. Next month’s article will explain steps that charities can take when faced with the missing annuitant problem. It will also provide guidance for professional advisors to assist their clients – whether an annuitant, an agent acting under power of attorney for an annuitant, or the executor of the estate of an annuitant. An advisor may help their client communicate with the charity, thereby ensuring clients continue to receive annuity payments where appropriate.

Overview of Charitable Gift Annuities


A charitable gift annuity is a contract between a donor and a charity. To establish a CGA, the donor makes a gift of cash or property to the charity and, in exchange, the charity contractually agrees to make payments to one or more annuitants. Sec. 514(c)(5).

Charitable Deduction Rules

A gift made to fund a CGA provides the donor with a charitable income tax deduction. However, the donor is not allowed to take a deduction for the full amount transferred to charity. Rather, under Internal Revenue Service rules, the donor is only allowed a deduction equal to the present value of the “charitable interest.” To determine the deduction, the value of the gift is divided into two parts. The first part represents the present value of all future income payments to the annuitants. This amount is then subtracted from the gift amount to determine the charitable interest, which is the amount the donor deducts on their income tax return.

Taxation of Annuity Payments

In addition to the charitable income tax deduction, a CGA also provides other tax benefits. A portion of the payments received by the donor will be considered a tax-free return of the donor’s principal. Reg. 1.1011-2(c). If the donor used appreciated property to fund the annuity, a portion of the annuity payments to the donor will be taxed at capital gains tax rates rather than at the donor’s ordinary income tax rate. During the life expectancy of the donor, determined at the time the annuity was created, the donor will continue to receive this tax-free return and the more favorable capital gains tax treatment. If the donor lives past the previously projected life expectancy, all post-expectancy annuity payments will be taxed at ordinary income tax rates.

Example 1 – At 80 years of age, Donna funded a charitable gift annuity with $10,000 cash. She will receive $680 in payments each year, of which, $548 will be tax free with $132 taxed as ordinary income. If Donna lives beyond her life expectancy, 12.6 years at the time she set up the CGA, all payments received after that time will be considered ordinary income.

Payment Frequency

CGAs can be set up to make monthly, quarterly, semiannual or annual payments to the beneficiaries. As a contractual obligation, the annuity payments are secured by the assets of the charity. Most charities maintain an annuity reserve fund, which is required by some state insurance commissioners. However, the endowment, real property and other assets of the charity stand behind the promise to pay a gift annuity. Sec. 514(c)(5).

There is a higher likelihood a donor may forget about the annuity payments when there is a greater time period between each payment. Consequently, with a change in address or change in circumstances, an annuitant may forget to notify the charity. If a client is considering making a gift to fund a CGA, their advisor should talk with the client and charity about strategies to ensure the client will not become a missing annuitant.

Annuity Beneficiaries

CGAs must make payments for either one or two lives. With respect to one-life annuities, the annuity can be set up to make payments to the donor. Alternatively, the donor may wish to set up a one-life gift annuity to benefit a friend or a family member.

With respect to two-life annuities, the annuity functions either as a “joint and survivor” or “successive” annuity. A donor may choose to fund a two-life joint and survivor gift annuity for the benefit of the donor and another individual. With a joint and survivor annuity, the annuity payments are made to both persons simultaneously and then, upon the death of one of the annuitants, the surviving annuitant receives the annuity payments in their entirety.

Example 2 – Ellen made a gift to her favorite charity to fund a CGA for herself and her husband Harry. The charity will write both of their names on the annuity payment checks until either Ellen or Harry pass away. Upon the death of either Ellen or Harry, the annuity payments will be made to the surviving spouse.

The donor may wish to set up a successive gift annuity instead. With a successive gift annuity, the donor receives payments for life and, upon the donor’s death, payments are made to a second annuitant, if that individual survives the donor.

Example 3 – Donna funded a CGA, payable to herself for life and then to her son Sam if he survives her. If Sam predeceases Donna, then upon Donna’s death the remaining value of the annuity will be retained by charity. If, however, Sam is alive at the time of Donna’s death, he will receive the annuity payments for the rest of his life.

Annuity Types – Current, Deferred or Flexible

A gift annuity can be set up to commence immediately, a year or more in the future or, alternatively, a donor may choose a flexible payout date option. A current or immediate gift annuity is an annuity that will commence payments to the annuitant(s) within one year of the annuity’s funding date. By contrast, a deferred gift annuity will begin to make payments to the annuitant(s) on a fixed date that is more than one year after the gift annuity was created. Another payment start option is a flexible deferred gift annuity. Unlike the first two options, a flexible annuity does not have a locked-in first payout date. Instead, a flexible deferred CGA permits the donor to elect when payments will commence. If the donor decides to start payments before a specific “target date,” then the annuity payments will be reduced. Alternatively, if the donor decides to defer the first annuity payment beyond the target date, then the payout amount and preferred tax treatment of the annuity will be adjusted accordingly.

Due to the nature of deferred and flexible deferred annuities, there can sometimes be 10, 15 or even 20 years between the time the annuity was funded and the commencement of annuity payments. With these kinds of gifts, it is important that the charity, the donor and the donor’s advisor continue to keep in touch to make sure the charity has the annuitants’ address on file so that the annuitants can continue to receive their payments.

Missing Annuitant Scenarios


The missing annuitant problem typically occurs following a change of address or a change of circumstances for the annuitant. The more common scenarios include the following:

Retirement and Change of Address

Among the causes that result in a missing annuitant is an annuitant’s change of address. Very often this occurs if the annuitant has downsized his or her residence or has retired and moved out of state. Following a change of address, the annuitant may forget to notify the charity.

Example 4 – Nelson and Winona are married and work together in their custom framing shop. In July 2014, when they were both 72, they funded a two-life charitable gift annuity with their favorite charity. When Nelson and Winona funded their CGA, both expected they would continue working for years to come. The charity made the first annual annuity payment to Nelson and Winona on January 1, 2015 in the amount of $9,200. In June 2015, following Winona’s change in health, Nelson and Winona retired, sold the business and their home and moved to Florida. With all of these changes, Nelson and Winona forgot to advise the charity that they had moved. When the charity sent the January 2016 annuity payment it was returned as undeliverable by the postal service. Despite the charity’s best efforts, the charity was not able to find a current address for Nelson and Winona.

Change of Circumstances: Long-Term Care

A change in address can also occur when an annuitant moves from an independent living situation to a nursing home or long-term care facility. This situation is often emotionally difficult and, therefore, it is easy for the annuitant and family to overlook the need to notify a charity of the change in circumstances.

Example 5 – Harriet is 90 years old and, until recently, was living independently in a small condo she had purchased with her late husband, John. Harriet and her children have decided she is no longer able to live in the condo and that it would be best if she moved to a nearby long-term care facility. Nearly 15 years ago, John used his will to establish a one-life testamentary charitable gift annuity. The annuity, which was issued by a local charity, named Harriet as the beneficiary. When Harriet moved into the long-term care facility, she and her children failed to notify the charity that Harriet’s circumstances and her address had changed. Even though Harriet now lives only a few blocks away from her old condo, the charity was unable to locate Harriet to continue to make the annuity payments.

Incapacitation

There are also situations that can arise with respect to an annuitant where, through unfortunate circumstances, the annuitant becomes incapacitated. In such a case, very often someone else is acting under a power-of-attorney to manage the affairs of the annuitant. The attorney-in-fact may be unaware of the existence of the annuity and the right for the annuitant to receive payments.

Example 6 – Marshall is a 75-year-old widower with two grown daughters, Anne and Belinda. Sixteen years ago, Marshall made a gift to his favorite charity to fund a deferred one-life charitable gift annuity. In accordance with the annuity agreement, monthly annuity payments would commence on Marshall’s seventy-fifth birthday. About six months before Marshall’s seventy-fifth birthday, Marshall, an active cyclist, was struck by a car and severely injured during a bicycle ride. The accident left Marshall with traumatic brain injury and he has been in a coma ever since. Anne, acting under a power-of-attorney, manages her dad’s finances. When Marshall turned 75, the charity sent the first annuity payment to the post office box that Marshall had provided when he funded the annuity. The payments were delivered each month to the post office box but the checks were never cashed. Anne, however, was unaware that her father had a post office box or that he was entitled to the annuity payments. After a year, Roger, the charity’s CFO, began to wonder why Marshall’s annuity payments had not been cashed or why they had not been returned as undeliverable. Roger tried to contact Marshall to confirm if Roger had received the checks but was unsuccessful.

Primary Annuitant Passes Away


Another scenario that gives rise to the missing annuitant problem occurs when a donor makes a gift to fund a successive two-life CGA that will make payments, first, to the donor and then, after the donor passes away, to a secondary beneficiary for that person’s life. In this case, the charity may be aware that the donor has passed away but the charity is unable to locate the successor beneficiary.

Example 7 – Eight years ago, Miriam, who was 88 years old at the time, funded a CGA with her favorite charity. The annuity was established to make monthly payments to Miriam for life. Once Miriam passed away, the annuity would continue to make payments to Miriam’s sister, Maude, if Maude was still living at the time of Miriam’s death. Five months ago, Miriam passed away and her obituary stated that Miriam was survived by her sister Maude. Allen, a staff member at the charity, attended Miriam’s funeral. He had hoped to meet Maude and let her know that Miriam had established the annuity and that she was a beneficiary. Maude, however, did not attend the funeral. In fact, Allen was told by Miriam’s son, Dale, that Maude was estranged from the family and that, except for his late mother, no one in the family had spoken with Maude in years or even knew where she lived. Allen used his best efforts to locate Maude but was unable to do so.

Conclusion


A charitable gift annuity can provide a donor with several nice tax benefits as well as regular, fixed payments for life for one or two annuitants. Accordingly, a CGA can be a good tool to help donors achieve their philanthropic and planning goals.

Periodically, however, a change in address or other circumstances may make it difficult for the charity to continue to make the required payments to a beneficiary. We have looked at four case studies that illustrate the missing annuitant problem, a problem that affects both the charity and the annuitant. When confronted with this situation, charities will go to great lengths to try to locate a missing annuitant.

Next month, we will discuss some of the strategies that charities might use when confronted with a missing annuitant. We will also discuss how a professional advisor can counsel their clients who are annuitants or who are acting on behalf or for the benefit of an annuitant or the estate of a deceased annuitant.

Published August 1, 2016
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Previous Articles

LEGACY IRA Act

Supporting Organizations — Part II

Supporting Organizations — Part I

The Benefits of Charitable Lead Trusts: Part III

The Benefits of Charitable Lead Trusts: Part II

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