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.

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