Analysis of the New ACGA Annuity Rates

On December 29, 2008, the American Council on Gift Annuities (ACGA) announced it would soon publish lower recommended gift annuity rates to replace the rates that became effective on July 1, 2008.  On January 7, the ACGA made the new rates available.  The rates will apply to gift annuities established on or after February 1, 2009, although a charity may follow the new rates immediately if it wishes.

The ACGA reaffirmed these rates on June 18, 2009.

ACGA Suggested Annuity Rates, Effective February 1, 2009 

Assumptions Underlying the New Annuity Rates
The ACGA has made the assumptions listed below in determining its new schedule of suggested maximum annuity rates.  Of the following, only the fourth assumption has changed from previous years. 

1. The residuum realized by the charity upon termination of an annuity is 50 percent.



2. Life expectancies are based on the Annuity 2000 Mortality Tables for female lives with a two-year setback in ages. The rates also incorporate projections for increasing life expectancies.
   
   
3. Annual expenses for investment and administration are 1.0% of the fair market value of gift annuity reserves.
   
   
4. The total annual return on gift annuity reserves is 5.25% percent (down from 5.75%).
   
   
5. The rates for the youngest and oldest ages are somewhat lower than the rates that would follow from the first four assumptions to ensure that all immediate payment gift annuities have a contribution value that is at least 10% of the funding amount.

Immediate Payment Annuity Rates Will Decrease
For annuitant ages 80 and under, the new single-life and joint-life rates will be 0.4% - 0.7% lower than the rates they replace.  The decreases will be greater at ages over 80, with the new single-life rates topping out at 9.5% for annuitants age 90 and above and the new joint-life rates capping at 9.3% for two annuitants age 93 and above.  These rate maximums for the oldest annuitant ages are a full 1.0% lower than the current ones.

While the new rates will reduce annuity amounts, they will also tend to increase charitable deductions.  The figures in the table below are based on a $10,000 immediate payment gift annuity that makes payments quarterly, and a January 2009 IRS discount rate of 2.4%.

Comparison of New and Old ACGA Rates

* The present value of a gift annuity's payments must be less than 90% of the value of the property contributed in order for the arrangement to qualify as a charitable gift annuity.  As a practical matter, this means the charitable deduction must be at least 10% of the value of the property contributed.  A charity that issues a non-qualified charitable gift annuity may incur adverse tax consequences.   The new ACGA rates are designed to yield a deduction of at least 10% for all immediate payment gift annuities down to an IRS discount rate of 2.4%.

The ACGA has reduced the compound interest factor for deferred gift annuity (DGA) rates from 4.75% to 4.25% for all deferral periods.  This means that the deferred annuity rate will increase 0.5% less per year under the new recommendations than under the current ones, compounded annually for each year of deferral.  As a result of this reduction, as well as the decrease in the immediate payment annuity rates to which the compound interest factor is applied, the longer the deferral period, the greater the difference will be between the old DGA rates and the new ones.

The figures in the table below show how the ACGA recommended rate for a DGA deferred 5, 10, or 15 years will change under the new schedule.  The annuity amounts are based on a $10,000 funding amount.

New DGA Rates vs. Old DGA Rates

Despite the decrease in deferred annuity rates, the gap between the ACGA's deferred interest factor of 4.25% and the prevailing IRS discount rate of 2.4% makes it possible for a deferred annuity that follows the ACGA's suggested rate to fail the 10% deduction test. Failure is most likely to occur when there is little chance the annuitant will die before payments begin; that is, the annuitant is relatively young and the deferral period is short. For example, a deferred annuity for a 50 year-old who defers payments five years will fail the 10% test, but will pass if payments are deferred ten years. In the case of a "tuition assistance plan," a commuted payment gift annuity for someone of school age or younger, the gift will fail the 10% test for pretty much all deferral periods. If you run a deferred gift annuity calculation that fails the 10% test, solutions include lowering the annuity rate below the ACGA rate (be sure to disclose this to your donor) or lengthening the deferral period until the deduction exceeds 10%.

Deferred annuity rates for NJ and NY
The ACGA has not issued new deferred interest factors for use in New Jersey and New York.  However, the new 4.25% deferred interest factor is equal to or less than the interest factors currently dictated by New Jersey and New York for determining maximum allowable gift annuity rates.  Consequently, the new ACGA rates for deferred gift annuities should, in all cases, comply with the current maximum rate limitations in New Jersey and New York without modification. New Jersey and New York ordinarily announce their maximum interest rates for the year in the fall, so we expect the new ACGA rates to continue to meet New Jersey and New York limitations through at least August 2009.

What if the IRS Discount Rate Dips Below 2.4%?
As noted above, charities should generally avoid issuing a gift annuity that generates a deduction of 10% or less of the funding amount, since doing so can create thorny tax problems for the organization.  The new ACGA rates preserve gift annuity deduction percentages of at least 10% for all annuitant ages down to January 2009's all-time low IRS discount rate of 2.4%.  While it is hard to imagine that the IRS discount rate can go much lower than 2.4%, should the IRS discount rate descend still further to a new all-time low of 2.0%, the new rates will still result in deductions of more than 10% for single-life annuitants who are 56 or older, and for joint-life annuitants who are both 64 or older.  These ages are well below the age range of the typical immediate payment gift annuity beneficiary.

Note that Planned Giving Manager issues a warning whenever it computes a gift annuity deduction of less than 10%.  If you find yourself in this situation, the solution is to reduce the annuity rate you have entered in the Gift Options window until the deduction exceeds 10%.

Using the New ACGA Rates in Planned Giving Manager
Planned Giving Manager 6.1C (PGM), released the day after the ACGA announced its new rates, includes the new ACGA rate tables, as well as a few other enhancements.  Once you have installed this updated version, PGM will continue to pick gift annuity rates from your current gift annuity rate table.  If you wish to use the new rates at any time prior to February 1, 2009:

1. Open Customize – Gift Annuity Rate Tables in the PGM Menu Bar.
2. Select "ACGA Rates Effective 2/1/2009," then click Done.  PGM will now set default annuity rates using the new ACGA rate table.
3. To continue to use the new rates in subsequent PGM sessions, open File – Save Configuration, then click Save.

Regardless of the gift annuity rate table you have selected in PGM, you will be prompted to choose a gift annuity rate table the first time you launch it on or after February 1, 2009.  "ACGA Rates Effective 2/1/2009" will be the default choice, unless you use a custom gift annuity rate table, in which case your custom table will be the default choice.  At this time, click the rate table you wish to use going forward, and then click Done.  PGM will save this configuration change for you automatically.

Offering Gift Annuities in the Current Environment
Despite the reduction in ACGA rates, some charities may be considering the suspension of their gift annuity programs in light of current economic conditions. While a charity that takes this step will avoid incurring more liability, it will do so at the expense of bringing in additional gift assets that more than offset the increase in liability.  For example, if your organization takes in a $10,000 gift annuity with a reserve requirement of $7,000, the financial position of its reserve fund will improve by $3,000.

In addition, suspending your organization's program will not reduce the risk inherent in its existing gift annuities.

Although it may seem counter-intuitive, suspending your organization's program at this time could increase its annuity risk for the following reasons:

• Gift annuity rates paid on new annuities will be significantly less than the rates being paid on most of the annuities in your organization's portfolio.  Therefore, these new annuities are likely to result in larger balances.

• If your organization takes in new money for gift annuities and invests it when the market is down, it has a good chance of generating surpluses from the new annuities that can help offset possible losses on the older ones.  The annuities that have the healthiest balances today were those established at the bottom of the market in the early years of this decade.

Conclusion
Gift annuities will remain a key element of many planned giving programs.  While the ACGA has decreased rates significantly across the board twice in the last eight months, commercial annuity rates and the interest rates available from alternative sources of cash flow, such as CDs, money market accounts, and savings accounts, have also reached historic lows.  Gift annuities will still be attractive to a broad range of philanthropically motivated donors who are interested in the security of fixed payments.  At the same time, the ACGA's recommendation of this latest set of reduced rates should be viewed as a welcome step to help ensure that charities will enjoy significant benefit from their gift annuity programs long into the future.