Charitable Gift Annuities

When Financial Advisors Get Creative….

Quick Planned Giving lesson on Commercial Annuities

I couldn’t resist using this cartoon again but this time (to see previous post on commercial annuities – click here), I have a crazy scenario that just played out with a professional advisor who tried to foist a commercial annuity into a CGA on behalf of an unsuspecting intended charity.  See that previous post for more about commercial annuities – this post will just cover one of many disastrous scenarios that could occur.

Here are the facts as presented to me (with small changes to protect the innocent).  A friend (a planned giving director) calls last week with a nervous message, something about a donor giving them a commercial annuity (which I know doesn’t work).   What I find out when I get through to him is that the donor funded a commercial annuity that was somehow placed in the name of the charity but would pay lifetime annuity payments to the donor.  Really strange and my initial reaction was to direct him immediately to competent legal counsel.

After mulling this story over, and hearing a few more details, this is a must read post for planned giving professionals.

What happened here?  The planned giving director had given the professional advisor a CGA illustration on the donor.  Instead of finding out how CGAs work, the advisor decided to ask a really big insurance company (presumably one he is affiliated with) to somehow make the scenario work.  I am guessing that meant to get the donor his lifetime annuity payments and the advisor his commission!  Oh yeah, maybe a second thought about the charity’s remainder – NOT.

What did this multi-trillion dollar insurance company (one that took hefty bailout money just a few years ago for being too big to fail) come up with?  Their solution was to have the donor purchase on behalf of the charity a $100,000 commercial annuity that would pay the donor his CGA rate for his life.  All’s well that ends well, right?  Donor gets annuity and a $100,000 deduction (according to the advisor, at least), advisor gets his commission, charity gets remaining funds in the commercial annuity when donor passes (advisor even told the planned giving director that the remainder was a $100,000 guarantee to the charity – we’ll see about that!)

Your mind should be churning a bit here.  Let’s go through each problem.

  1. Income tax deduction – The donor basically transferred to the charity $100,000 and immediately invested it (on behalf of the charity) into this commercial annuity.  Lot’s of problems here.  #1 donor control of investment is a no-no, meaning no deduction, zero, zilch.  Let’s say the charity had acquiesced retroactively.  Basically, the donor created his own CGA – at best the donor might be entitled to the appropriate CGA deduction.  Advisor’s claim that donor should get $100,000 deduction showed how completely ignorant he is on these matters.
  2. Commission – Let’s say charity said fine, we have a CGA here and the charity agrees that this investment is fine (which it probably is NOT for the NY State Dept. of Insurance – who would probably have forced this entire thing to be reversed if it ever got to their attention).  A big problem is that the advisor basically took a commission on the issuance of a CGA – a violation of the Philanthropy Protection Act (the Act that exempted CGAs, among other vehicles, from SEC regulation).
  3. Remainder – The advisor’s guarantee that the charity was guaranteed a full $100,000 was a complete untruth.  In fact, when the planned giving director inquired of the insurance company about what happens to the remainder, they told him that it basically extinguishes around the end of the life expectancy of the donor.  Nothing, zilch, for charity if donor lives to life expectancy.  Talk about chutzpah!
  4. NY Dept. of Insurance (NY-DOI) – Hate’em, yes, if you have to deal with them but in this case, there is no way they would have let this go (which is a good thing).  I know one scenario where an advisor had a CGA program reinsure all of its CGAs (a NY charity) and didn’t follow NY’s rules (which are particularly strict on reinsurance).  They forced that nonprofit to undo all of the transactions.  Not fun. This one would have been killed sooner or later (probably at the expense of the pg director’s job).

Let’s add it all up. Extremely doubtful deduction, illegal commission, horrific investment choice, NY-DOI will make you pay dearly.  I have probably even missed a few problems.

Why do such disasters happen?  Ironically, the worst planned giving disasters (besides the Huguette Clark estate) almost always involve attempts to  use commercial annuities in planned giving contexts.  Besides the reinsurance disaster mentioned above (that was about purchasing commercial annuities to cover CGA payments), I’ve dealt with disastrous use of commercial annuities as investments in CRTs several times and I just keep asking myself WHY?  Why in the world do advisors do such stupid things like this?

The answer, which my planned giving director friend also agreed with, was the drive to get a commission.  Yes, it comes down to dollars and cents.  Advisors need commissions – preferably cash upfront.  That is their lifeblood, their inspiration.  And, even though commercial annuities don’t pay the great commissions that life insurance policies do (which are insanely huge), they are probably enough for the advisor to sleep well at night.  Of course, if your prime focus is how you can benefit from this gift (you meaning the advisor), you might not pay too much attention to small details like any remainder for the charity.

I had an advisor once defend a case where donor/client put up $25,000 in insurance premiums for the first five years of a policy and by the 6th or 7th year, the policy was already lapsing for nonpayment.  The donor had wanted to give $25,000 to get a $100,000 policy (and leveraged naming gift).  But, the policy needed another 20 years of premiums or more.  Charities almost never pay premiums, certainly not mine at that time.  The advisor skipped that issue when setting up the policy – what should he care?  He got his commissions from the first payments.  I confronted him (and even had pro-boon counsel ready to make his life miserable) and he didn’t show the slightest feelings of guilt. It dawned on me then that singular focus by advisors on their commissions is a dangerous thing.

Back to our story.  Luckily for all involved, there is a 30 day “get out of jail free card” when buying commercial annuities.  The whole thing is being undone.  Somehow the donor isn’t angry, advisor came up with some excuse, and the charity will issue a CGA after all.

Ironically, if this advisor had any clue, he could have advised the donor to set up a CRT and continued to manage the money and continued to get some commissions.  Of course, he probably did better with the immediate commission from the commercial annuity in the short term.  Now, he get’s nothing, which should make us all feel a  little better about this story.

And, sadly, this story confirms how insurance companies are utterly ignorant of this stuff.  How could a room full of guys (who all drive BMGs and Porches) be so stupid? I would love to train advisors but they will have to learn to change their outlook to get a clue on planned giving.  It can’t be about your silly $2 commission.  It has to be about finding the best options for your clients!  And, they might have to actually use their brains a bit.

Anyway, the bottom line with commercial annuities in a planned giving context is this: They never work (except for simple beneficiary designations) and are actually very dangerous from a tax standpoint (to the donor and the charity).  In other words, stay away from them if an advisor is trying to slip one into a planned giving situation.

What Ever Happened to College Annuities?

I remember one of the leading planned giving directors at one of the largest, most successful planned giving programs in the country showing me how “College Annuities” were going to revolutionize grandparent giving to day schools and/or for college tuitions.

So exciting.  The day school plan was this: grandparent creates a commuted payment gift annuity that pays term annuity to child (used for tuition) and then at the end of the child’s stay in the day school, the remainder stays with the school’s endowment.  At the time, our quandary was the “kiddie tax” – that the children were likely to pay income tax at their parents’ rates.  The kiddie tax certainly put a damper on the plans as well as questions like “what if the kid leaves the school?”  In truth, the NY State Dept. of Insurance hadn’t yet approved these commuted payment annuities so we were just getting ready for what we assumed was an imminent change  (Ironically, NY never did approve them, as far as I know).

What happened to these revolutionary CGAs?  Any planned giving professional can tell you stories about grandparents and parents wanting to do something for their offspring – this seemed to be a great solution to that problem.

Well, in preparing to give an advanced class on CGAs, I thought to expose the audience to the commuted payment annuity concept.  Outside of NY, they can be done and I have done some with donors (just none with the day school or college tuition plan).  So, I entered into PGCalc a 13 year old annuitant who would start receiving payments in 5 years for 5 years (college now take 5 years, if you hadn’t heard).

Lo and behold (to my own ignorance on this issue), PGCalc warned me of an unintended consequence of doing a commuted payment annuity with a “life” under age 59 1/2.

WARNING: THIS COMMUTED PAYMENT GIFT ANNUITY MAY BE SUBJECT TO INTERNAL REVENUE CODE SECTION 72(Q), WHICH IMPOSES A 10% PENALTY TAX ON PREMATURE DISTRIBUTIONS FROM ANNUITY CONTRACT TO ANNUITANTS UNDER AGE 59 1/2.

In my own quick research, I found a legal memo online that said that while the IRS did approve commuted payment CGAs over a series of Private Letter Rulings (Ltr. Ruls. 9527033, 9407008, 9108021, and 9042043), a negative consequence came to light in those rulings – that any commuting of annuity payments to someone under age 59 1/2 would be subject to the 10% early withdrawal penalty applicable to annuities under Section 72(q).

Ouch.  Let’s forget there was ever such a thing as College Annuities.  Outside of NY, we still have commuted payment CGAs but only for those older than age 59 1/2.

Next idea?

Cool but tricky gift annuity ideas

Welcome new subscribers to the Planned Giving Blog – thank  you for joining our 800 subscribers!  This week though I came across some interesting gift annuity issues that I think are important to think about.

Flexible deferred gift annuities are totally OK if you are licensed in NY (to issues CGAs)

That is the good news but there are some serious caveats.  If you were wondering, the flexible CGA is a deferred CGA in which the donor can choose when payments are to start (with at least a one year deferral to start). Each year the donor delays, his/her potential payment jumps to reflect an additional deferral year.  A really cool option for many reasons, besides the fact that it is a great way for a donor to “wait and see” as their right to income increases dramatically each year they don’t activate the CGA.  I have pitched these where the donor is not sure he/she will even need the income or they want some sort of hedge to see if the nonprofit does what it says it will do.  In other words, the donors may choose never to take the payments! Also, the contract itself lays out what the new payment plan would be each year, avoiding potential conflicts with your donors in the future.

Here is what makes them tricky if you are licensed in NY.  The NY guide on CGAs from their Dept. of Insurance states that Flexible Deferred are ok if the contract is for up to 20 years of payment options.   Beyond a 20 year schedule, you need approval from them for your contract.  What a headache and who knows how long they will take and how much nit-picking they will do over the language of your contracts.  NY Dept. of Insurance attorneys are known for ridiculous scrutiny over every punctuation mark and even reject previously approved language.  To make matters worse, NY expects you to only use pre-approved agreements, in general.  Have you gotten your Flexible Deferred CGA agreements approved?  Have you gotten the language of your other contracts approved!

One client of mine ran into some trouble with the NY Dept. of Insurance, apparently ignored their demand letters, and received a cease and desist letter from issuing new CGAs until they dealt with whatever the issue was.  This issue of contract language had become a big problem for them and they had to return a really large amount of money to a recent annuitant to undo their CGA since it happened during the suspension period.  Yikes.  You can guess that a consultant (me) was needed in the absence of the fired planned giving director (lesson for anyone in charge of planned giving programs – don’t ignore those legal letters!).

All of this reminds me how annoyingly complex running national CGA program can be.  Basically, your program better bring in enough CGAs to justify significant staff time overseeing the program’s legal/registration issues or maybe it’s time to think twice about issuing CGAs in every state (particularly NY and CA).

CGA funded with an Estate Note?

This idea come up yesterday with a client.  What is the difference between an irrevocable estate note (irrevocable pledge) and a life estate?  Life estates offers donors a charitable deduction and a charity in theory can accept a life estate for a CGA.  A legally binding pledge/note against your estate doesn’t offer a deduction but who is to say it isn’t any riskier than a life estate in real estate.  Why not allow a donor to sign a legally binding commitment to an amount out of his/her estate and the charity gives him/her a gift annuity for the present value of the committed amount.

Now, you have ask the obvious – why in the world would the nonprofit commit to paying a lifetime annuity when all they have is a pledge agreement?  Yes, there has to be assets at the nonprofit (whether given by this donor or not) which they can park in their CGA pool to replace the present value figure to rely on to cover the payments.  Assume that is the case.  Any other issues with this plan? Am I treading in S. Prestley Bake territory (for the legal nerds out there) – the namesake for my law school (which happens to be considering a change to The Lois Lerner Law Center :)

Stay tuned as I work on this one…..

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Planned Giving Criminals?

Oh, yes, there are a few.

For now, this story seems to have flown under the radar – not picked up yet by the Wall Street Journal or the NY Times.  Probably a matter of days because it seems to fit a popular line of journalism in this area of focusing on the bad apples.

In brief, Richard K. Olive and Susan L. Olive allegedly went around selling charitable gift annuities and other means of giving on behalf of a phony charity, to line their own pockets, etc…  The amounts stolen are at a minimum $30 million (Mr. Olive was just convicted on that amount on federal charges) and upwards of $70 million or more (alleged in an SEC press release on different charges).

Here is a link to the SEC’s press release on the story if you are interested in the details: http://www.sec.gov/news/press/2013/2013-19.htm

And, here is a link to an article about how the scoundrel named in the above indictment was just convicted in Tennessee federal court on similar abuses of charitable gift annuities: http://www.investmentnews.com/article/20130312/FREE/130319983#

Always sad when this stuff hits the news – definitely sends the wrong message about an industry that is generally very honest and almost always helping individuals do good with their money (while helping themselves, too).