By Joseph K. Thiegs, J.D., FCEP
June 2, 2020
The IRS announced a new record-low Section 7520 rate for June 2020, at 0.6%. See https://www.irs.gov/businesses/small-businesses-self-employed/section-7520-interest-rates. This rate is published monthly by the IRS and is used to determine the value of annuities, life estates, income interests, and remainder interests for certain transfers, including charitable split-interest gifts. While these record-low rates provide unprecedented high charitable deductions for gifts with retained life estates and charitable lead trusts, one downside–besides lower charitable deductions for charitable gift annuities and charitable remainder trusts–is the potential for charitable gift annuities and charitable remainder trusts to fail the requirement that at least 10% of the actuarial value of the contribution must be designated to charity. (Additionally, charitable remainder annuity trusts must pass a probability of exhaustion test, which prohibits a charitable deduction for CRATs where the actuarial probability that the trust will be exhausted before the end of the trust term is 5% or greater. The low Section 7520 rate puts some limits on permissible CRATs too, but we’re focusing here on CGAs because they’re so much more common.)
The risk primarily applies to gift annuities with payouts at the American Council on Gift Annuities (“ACGA”) maximum recommended rates currently in effect (as of June 2020) that are issued for annuitants below certain ages. Because a donor can elect to use the Section 7520 rate either for the month of the gift or either of the two prior months, a CGA for a younger annuitant may warrant taking advantage of that election to make sure that the CGA qualifies for a deduction, or to increase the deduction if desired. The following charts show the annuitant ages, payout rates, and Section 7520 rates (for April, May, and June 2020) at which the 10% charitable remainder test becomes a potential or actual issue.
(If anyone wants to double-check my results and if there are corrections to be made, please let me know.) Note that this is an issue really only for rather young annuitants (or, potentially, for CRTs with unusually high payouts, not illustrated here). Many nonprofits that issue gift annuities have age minimums above the ages at which CGAs begin to fail qualification. Still, the gift acceptance policies for many other organizations do allow for one-life gift annuities starting lower ages–at age 55, for example–or two-life gift annuities at age 60, either of which could be a problem in the current interest rate environment.
Please also note that the ACGA is recommending new maximum rates for gift annuities, effective July 1, 2020. See https://www.acga-web.org/gift-annuity-rates. The new table for one-life gift annuities has been published, and while I did not test every age and rate, a significant sampling of ages and rates down to age 10 showed no failures with CGAs using a Section 7520 rate of 0.6% or higher under the new July 2020 recommended rates. Kudos to the good folks on the ACGA Rates Committee and Board for this update! The new two-life recommended rates table is expected to be made available sometime next week.
For conversations about gift annuities with donors this month, though, be aware of the potential issue for annuitants on the younger side. Make sure to double-check illustrations and communicate early if there are any deduction problems using any of the available Section 7520 rates. Many donors will be willing to accept a lower annuity rate, resulting in a larger deduction and ultimate gift to your charity, if you explain and ask. (It’s probably a good idea to discuss it with your managers and/or CFO first, but they should be in favor because it means lower risk and larger gifts.) As my good friend Pam Davidson is fond of saying, remember that the ACGA recommended rates are maximum rates, not minimums.
The upcoming decrease in CGA rates is a relatively rare opportunity to encourage donors to consider establishing gift annuities before the end of the month. At the same time, it’s important to be aware of this potential trap for the unwary, and to help your donors avoid any unhappy surprises. In this unsettling time, it’s more important than ever to look out for each other.
Questions and corrections to this article are welcome. If you have any questions related to planned giving or charitable estate planning, or if your organization could use any help with planned giving or endowment, please contact Joe at firstname.lastname@example.org. If you’d like to learn more about a highly effective values-based estate planning program for your donors through Thompson & Associates, contact Joe at email@example.com.