A New Way to Achieve Charitable Goals While Saving on Taxes

Charitable gift annuities, or CGAs, have long been a popular way for individuals with charitable intentions to plan their legacies. By contributing a lump sum to a charity in exchange for fixed recurring payments for life (with any leftover funds after the donor’s death going to the charity), the individual can ensure that their funds are directed toward a purpose that aligns with their values while also retaining a steady source of income for the rest of their life.

However, the caveat with current CGAs has been that they could be funded only with aftertax dollars before the donor’s death, meaning that if an individual had only tax-deferred funds (for example, in an IRA or 401(k) plan) to contribute to the CGA, they would need to withdraw—and be taxed on—those funds first. Testamentary CGAs, on the other hand, can be established after a donor’s death, funded with IRA or other assets to provide income for another person.

But the Secure Act 2.0, passed in December 2022, created the ability for individuals over age 70 1/2 to make a one-time qualified charitable distribution, or QCD, of up to $50,000 of IRA funds into a CGA, with the amount distributed to the annuity being excludable from the donor’s taxable income.

In this article, Kathleen Rehl, Ph.D., CFP, a semiretired financial advisor and educator now focusing on her own estate-planning considerations, shares her experience with creating her “legacy IRA” rollover to a CGA to support her chosen nonprofits after Congress passed the Secure Act 2.0.

The potential benefits of the new legacy IRA rules are threefold. First, they allow donors to enhance their charitable giving legacy and ensure their future charitable intentions are fulfilled. Second, they reduce the donor’s tax bill in the year the CGA is created by excluding the amount contributed to the CGA from taxable income. And third, they create a stable lifetime income stream that can be paid to the donor and/or their spouse.

All of this is important during a time when members of the baby boomer generation, who have accumulated unprecedented levels of wealth compared with previous generations, are preparing to make decisions on how to balance their intentions for transferring that wealth—whether that be passing it on to the next generation of family members or friends, or providing for causes that are meaningful to them—with their own needs for sustainable retirement income. While a legacy IRA may be just one piece of the puzzle (since the $50,000-per-person lifetime limit may represent only a small portion of the assets of many high-net-worth families), it can still serve as a unique and valuable legacy and tax planning tool. And given the minimal expense and hassle of setting up and maintaining the CGA (since the charitable organization typically handles all of the administrative aspects of doing so), there may be no reason for any individual with charitable intentions and lifetime income needs not to use it to the extent that the one-time $50,000 limit allows.

Ultimately, for financial advisors, the legacy IRA can be one part of a broader toolkit for helping retired clients with values-based, purposeful legacy planning. By understanding the eligibility requirements and rules around the new law and gift annuities in general, and having a “recipe” that clients can follow for establishing their own legacy IRAs, advisors can help plant the seeds with their clients around strategic giving (while also differentiating themselves to potential new clients as a go-to resource for estate planning and charitable giving).

Now, here’s Kathleen:

My Values Align With Charitable Giving

I grew up on a small Wisconsin farm. With my parents working day jobs in town and tackling farm chores evenings and weekends, we still struggled financially. However, Mom and Dad managed to give back to their community by putting a little in the church offering plate passed on Sundays. Those charitable seeds planted decades ago became the basis for my purposeful philanthropic philosophy and my charitable stance today. I also believe that the more I give, the more I get in return—meeting interesting people, enjoying remarkable experiences, creating new ways of seeing the world, savoring fun times with loved ones, and sometimes even benefiting financially.

It’s said that we are happiest when our lives have meaning and have a positive impact. That includes expressing gratitude for the blessings I’ve received during my lifetime. One way I can actively demonstrate appreciation is through my giving. Especially during our current (unprecedented) time of intergenerational wealth transfer and the longevity economy, there are implications for philanthropy and other boomers like me. For example, it’s not my goal to leave everything I’ve worked a lifetime for to my family. Instead, I’ve arranged for them to inherit some while providing for charities I cherish. Many of my friends mirror this view.

Some folks like to follow a recipe, a cookbook of sorts; such readers will find that offered here in my story, where I share my own experience of how I established a legacy IRA (made available through the Secure Act 2.0 of 2023) to a charitable giving annuity, in part to encourage those who are charitably inclined and meet the eligibility requirement of the new law to think about establishing their own personal legacy IRAs. This tool can be especially useful for middle-income Americans who appreciate the tax benefits in addition to the income they receive. Additionally, legacy IRAs offer a remarkable opportunity to enhance future charitable giving, decrease taxable income, and increase fixed-income earnings.

I hope my story inspires financial advisors to consider including legacy IRAs as a new tool in their toolkits when helping retired clients with values-based, purposeful legacy planning.

The Legacy IRA Is Born

In the final week of 2022, Congress passed Secure Act 2.0, formally known as the Consolidated Appropriations Act of 2023 (H.R. 2617). This massive $1.7 trillion spending bill included a unique present for people who want to give to charity and get tax breaks simultaneously. Section 307 of the Secure Act 2.0 permits a once-in-a-lifetime IRA rollover to an income plan that gives them regular payments throughout their lifetime.

Notably, this new law expands the “charitable IRA rollover,” achieved after more than a decade of lobbying efforts. IRC Section 408(d)(8) was introduced in 2006 as a temporary solution, extended several times, and made permanent in 2015. It allowed those aged 70 1/2 years and older to make an outright gift as a QCD of up to $100,000 from their IRA.

As of Jan. 1, 2023, a QCD of up to $50,000 is now allowed for individuals aged 70 1/2 or older to create a legacy IRA, which generally involves a traditional IRA rollover to a CGA (explained in more detail below). Depending on the minimum level designated by the administering nonprofit, a lesser amount is possible, though most organizations require at least $10,000. Additional assets cannot be added later. This limited one-time legacy IRA rollover into a life income plan was made possible by amending Internal Revenue Code Section 408(d)(8).

Life-income gifts were not permitted before, but now three types are allowed: an immediate CGA; a standard payout charitable remainder unitrust, or CRUT; or a nonassignable charitable remainder annuity trust, or CRAT. Although CRUTs and CRATs are allowable, logistics generally rule out these two alternatives. For example, most charitable remainder trusts are typically funded at no less than $100,000 to be financially sustainable. This means the $100,000 QCD limit can make it difficult to substantiate the setup of a CRAT or CRUT.

What Is a Charitable Gift Annuity?

A CGA, defined by IRC 501(m)(5), combines a life annuity with an irrevocable charitable donation. It’s a contract between an individual or couple and a nonprofit. In exchange for the donor’s gift, the nonprofit agrees to pay a fixed income to the donor (or the donor and their spouse) for their lifetime. When the income recipient dies, the annuity stops, and the remaining principal goes to the nonprofit specified in the gift annuity contract. With this traditional, vanilla-style CGA, it’s possible to create a gift annuity that pays income to someone other than the donor or the donor and their spouse. For example, I could create a CGA to provide lifetime income for my 60-year-old son. (Many charitable organizations that administer CGAs set the minimum age to be 60 for income recipients.)

CGA payout rates typically follow guidelines set by the American Council on Gift Annuities. The income payments are made to the individual for their lifetime. Depending on how a traditional CGA (that is, with contributions not from an IRA) is funded, the income payments may be classified as part tax-free return of principal, part capital gain, or part ordinary income.

CGAs are usually managed by reputable large nonprofits, including community foundations, universities, religious groups, human rights advocates, and cultural arts organizations. These charitable organizations accept and invest contributions from various CGAs, pooling reserve funds for effective management and distribution. The annual payment amounts are based on the donor’s age at the time of the contribution.

Notably, upon the donor’s passing, any remaining funds in the CGA will be allocated to the chosen nonprofit(s) either as an endowed gift or an outright cash gift. Depending on the organization administering the CGA, donors may specify different charities to benefit from the legacy beyond their lifetime.

With the new legacy IRA, IRA rollovers to a CGA are considered gifts that are not tax-deductible, but the tax-free IRA distribution could, if applicable, count toward the donor’s required minimum distributions, or RMDs, for the year. So, the amount rolled to a CGA can simultaneously fulfill part or all of the year’s annual RMD, benefiting donors age 73 (as RMDs begin for those reaching age 72 after Dec. 31, 2022) or older. All income payments from this legacy IRA rollover gift annuity are designated as ordinary income.

My Steps to Establish a Legacy IRA to a Charitable Gift Annuity

Consider my situation.

Throughout my working years to age 73, I diligently funded several tax-deferred retirement accounts, including a traditional IRA and various employer plans. In my early 70s, I merged those various accounts (except for a Roth IRA and an inherited IRA) into my traditional IRA at Vanguard. With most of my living expenses today covered by Social Security, two small pensions, and other investments, I withdraw only the RMD each year, which, for 2023, amounts to nearly $63,000. However, this mandatory withdrawal, which I don’t need to live on, pushes me into a higher tax bracket, with more income tax due!

By rolling over the maximum allowable amount of $50,000 from my IRA to a CGA, I will owe income tax only on the remaining RMD amount of $63,000 (total RMD amount) − $50,000 (rollover to CGA) = $13,000. The CGA gives me a stable, secure income for life, with the payout rate determined by my age. Signing my CGA contract at age 76, I now receive an attractive fixed payout rate of 6.8% on the $50,000 gift.

Alternatively, if I had included my younger spouse as a joint beneficiary until the second of us passed, the rate would have dropped to 5.9%. Considering that we remarried later in life after both of us were widowed years before and are both financially independent, I chose a single-life payout for myself only. Hubby agreed.

Exactly How I Did It

While setting up a legacy IRA is relatively simple, there are several steps involved. Here are the details of the process I followed to establish my own legacy IRA:

• Identified the charitable organizations I wanted to support with continuing financial gifts after I die. I named Soaring Spirits International, a nonprofit benefiting widowed persons and two religious congregations. I currently contribute to these three charitable organizations regularly. I liked the idea of providing support for them after I’m gone, through a legacy fund that would keep giving in perpetuity.
• Chose the Community Foundation Tampa Bay to administer my CGA. I selected this outstanding foundation because I already have a donor-advised fund with it. Also, since I wanted to benefit three different nonprofits through an endowment-type fund, I chose to work with an organization that could accommodate this request. When I approached the foundation, they were excited about helping me establish what would become its first legacy IRA.
• Reviewed the IRA-to-Gift-Annuity illustration prepared by the foundation with Crescendo Interactive. Since I had used this software for gifting illustrations with my financial planning clients over the years, I was familiar with this powerful program.
• Completed the brief application for a One-Life CGA agreement prepared by the foundation.
• Signed a one-page CGA agreement prepared by the foundation.
• Transferred $50,000 from my Vanguard traditional IRA to the foundation as a tax-free QCD. That was easy to do online, designating that the check be paid directly to the foundation. Giving this money to a nonprofit rather than to me as a required distribution will save me $12,000 in federal tax this year (in the 24% federal marginal tax bracket). It also reduces my Medicare Income-Related Monthly Adjustment Amount premium and the 3.8% surtax on net investment income.
• Signed the accompanying agreement to create the Kathleen Moore Rehl Legacy Fund. When I die, the remaining balance in my CGA will be transferred to my legacy fund, an endowment of sorts for the benefit of my three named charitable organizations. Annual distributions will be made forever. This legacy fund ensures that my support for these nonprofits continues long after I’m gone. Plus, I can direct additional money to the fund from other sources besides my legacy IRA if I desire. I anticipate doing this, providing more ongoing endowed income for the nonprofits that my legacy fund will support.
• Receive income from my CGA. The first deposit of income from my CGA was made in my bank checking account at the end of March. This fixed, stable income will be paid to me quarterly for the rest of my life, regardless of market fluctuations. In my case, I receive $3,400 annually based on my age of 76. That’s a 6.8% rate. Even if I outlive my life expectancy, I’ll continue to get this income.

I used to tell my clients that setting up a gift annuity would automatically guarantee a longer life span. Indeed, a 2020 global study suggests that generosity may help us live longer!

In a following article, I will explain how financial advisors can help their clients set up their own CGA.

Kathleen Rehl, Ph.D., CFP, CEFT Emeritus, owned Rehl Financial Advisors for 18 years before retiring to an active six-year encore career, empowering widows with her speaking, writing, and research. She is the author of Moving Forward on Your Own: A Financial Guidebook for Widows. This article first appeared on the Nerd’s Eye View at Kitces.com and has been reprinted here with permission.

The views expressed here are the author’s.