Group Calls for Modest Cut in Gift-Annuity Payout Rate

Charities should reduce slightly the payout rates offered to donors of gift annuities, an influential organization of planned-giving experts recommended last week.

Noting that interest rates, on which annuity payouts are based, are relatively low, the American Council on Gift Annuities suggested modest cuts in payout rates for donors in most age groups. The council also pointed out that some states limit the amount of gift-annuity assets that charities can invest in the stock market, which in recent years has paid returns far above interest-bearing investments.

The council, which attracted about 800 fund raisers and planned-giving consultants to its triennial meeting here, made its recommendation even though its recent survey of charity representatives found that most thought that the rates they were paying now were appropriate and did not need to be adjusted.

Gift annuities allow donors to contribute cash, securities, property, or other assets to a charity in exchange for fixed payments.

Immediate gift annuities allow donors to receive payments as soon as they set up the annuity. Deferred gift annuities allow donors to receive fixed payments starting one year or later from the date of the gift. Many of those deferred payments are structured to begin after a donor’s retirement.

Such payments are guaranteed to donors, and charities have a legal obligation to pay the amounts promised. That is why setting interest rates at the proper level is so important. If a charity sets its gift-annuity rates too high, it may owe a donor more money than it is able to earn by investing the donor’s gift in stocks, bonds, or the money market.

The assumption behind the council’s payout-rate calculations is that charities eventually will receive 50 per cent of the value of the gift. Most charities receive much more — sometimes as much as 90 per cent.

Under the council’s recommendations, payout rates for immediate gift annuities received after July 1 would be reduced 0.2 to 0.3 percentage points, compared with 1997 levels, for most age groups.

The council also suggested a quarter-of-a-percentage-point cut in the rate of return during the deferral period on deferred gift annuities. For example, a 50-year-old donor who obtains a gift annuity after July 1 and wants his payout to begin at age 65 would earn a rate that is 0.25-per-cent less during the 15-year deferral period than he might have received for an annuity obtained before July 1.

Charities are not required to follow the council’s recommendations, but most do.

The council last revised its recommended rates in 1997. Last week’s revision, however, was the first since Congress last year took action to exempt charities from antitrust measures in the wake of a 1994 lawsuit accusing the council of conspiring to keep annuity payouts artificially low through its practice of recommending rates.

The federal law that passed last summer was the second attempt by lawmakers to end the lawsuit. The case was filed by the grandniece of an elderly Texas woman who bought $200,000 in annuities from the Lutheran Foundation of Texas. The suit argued that the council operated like a cartel and conspired with charities nationwide to keep annuity rates artificially low.

While the lawsuit remains alive in the U.S. Court of Appeals for the Fifth Circuit, the Supreme Court signaled late last year that it wants the case to end, and many observers expect it to disappear in light of last summer’s Congressional action.

In arriving at the latest set of recommended annuity rates, the council said it considered historical and current returns on stock and fixed-income investments, mortality figures, administrative expenses, authorized investments in states that regulate gift annuities, and other factors.

Annuities pay a fixed sum each year, amounting to a percentage of the total gift, based on a donor’s age. The older the donor, the higher the annual payout, because the person is not expected to live as long as someone who is younger.

Since the value of the total contribution exceeds the value of the annuity payouts guaranteed by the charity, the donor can take a charitable-gift tax deduction for the difference.

Under the newly recommended rates, individual annuitants aged 84 and older would see no change in annuity payouts, but those aged 20 through 83 would experience a slight rate decline from 1997.

For example, a 65-year-old man who obtained a $100,000 annuity after July 1, 1998, would receive $7,000 per year for life, compared with $7,200 annually under an annuity obtained before July 1.

A $100,000 annuity obtained after July 1 by a married couple, both age 70, would generate $6,800 per year until both spouses were dead. That compares with $7,100 in annual payout for annuities obtained before July 1, though the newer annuity would merit a slightly larger tax deduction.

Frank Minton, chairman of the council’s gift-annuity rates committee, told the meeting that despite the suggested reductions, the latest recommended rates remain higher than historical levels for most years, going back to 1927, when the Committee on Gift Annuities — the council’s predecessor — was formed.

Even so, Mr. Minton, a planned-giving consultant in Seattle, suggested that charities have a minimal risk of losing money on gift annuities because of recently revised actuarial and financial assumptions that the council used to calculate its recommended rates.

Beginning in 1997, the council used the most recent mortality tables, which reflect the fact that Americans are living longer. The longer an annuitant lives, the longer a charity must make payments on a gift annuity.

In addition, the council based its recommended rates for immediate gift annuities on the assumption that charities will invest annuity money in a highly conservative manner and earn a return of 6.75 per cent before taking administrative expenses into account. To earn that figure, a charity would need to invest only 20 per cent of the gift annuity in stock, with the remainder invested in more conservative bonds and cash, assuming historic yields on stock and present yields on bonds and cash hold firm.

Charities operating in states without regulations on charitable gift annuities probably invest a significant percentage in equities, and in recent years their total returns have far exceeded the return on which the council rates are based, Mr. Minton said.

However, a number of states impose regulations on gift annuities, some setting limits on stock investments and many requiring charities to set aside reserve accounts to make sure that donors receive their annuity income even if the organization runs into money problems.

New York, for example, allows no more than 10 per cent of reserve accounts to be invested in stock, Mr. Minton noted.

Later this year, the National Association of Insurance Commissioners is expected to circulate among the states a model gift-annuity law. It would require charities that offer gift annuities to be licensed by state insurance regulators, set aside money in reserve accounts, and file an annual financial report with state regulators that details their annuity business and reserve accounts.

Proponents say that if states adopt the model law, it could bring consistency to gift-annuity regulation and reassure donors that their annuity income is protected. But critics of the proposed measure say that gift annuities already are safe and that it would make annuity programs more expensive, especially for smaller charities.

Currently, 10 states — Arkansas, California, Hawaii, Maryland, New Jersey, New York, North Dakota, Oregon, Washington, and Wisconsin — impose detailed regulations on charities that issue gift annuities; 13 states allow gift annuities to be exempt from state insurance laws if the charity meets certain conditions; 10 states grant a blanket exemption from insurance laws; and laws in 17 states and the District of Columbia do not address gift annuities at all.

For more information on the proposed rates, contact the American Council on Gift Annuities, 233 McCrea Street, Suite 400, Indianapolis 46225-1030, (317) 2696271; or Frank Minton, president, Planned Giving Services, 3147 Fairview Avenue East, Suite 200, Seattle 98102; (206) 329-8144.