Is your charity starting or already running a charitable gift annuity (CGA) program?  Congratulations, and we hope it is successful!  To that end, this posting — based on our experience — identifies common (and not-so-common) mistakes that can undermine a gift annuity effort.

Financial regulators are a savvy group.  There is a great deal of institutional experience in the federal and state agencies that concern themselves with CGAs.  These gift vehicles are hardly the new kids on the block.  As far as we know, the first gift annuity was issued by the American Bible Society in 1843.  (That organization is still issuing them!)  So, there are probably very few things that the “CGA police” have not seen.

Bypassing Federal Regulations

There is so much emphasis on state regulation of gift annuities that it is easy to overlook the pertinent federal rules, the bulk of which arose in the Philanthropy Protection Act of 1995 (PPA).  The most important of these provisions are the disclosure rules, which are different from the state mandates both in content and in timing.  For instance, PPA requires disclosures about the finances and governance of the issuing charity.  Most state regulations do not require that level of specificity.

Perhaps most importantly, the federal disclosures must occur prior to any deposit of money by the donor.  In our experience, the federal rules are frequently overlooked by CGA-issuing charities, probably because state-required disclosures come later in the process.  Federal enforcement action on charitable gift annuities is rare but decisive.

For example, in 2013, the Securities and Exchange Commission (SEC) filed a fraud action against a Florida charity that alleged, among other things, noncompliance with the PPA.  Why the SEC?  Because CGAs are investment products under federal law unless they meet precise requirements for exemption, including those imposed by the PPA.

Taking the “Home Field” View of Applicable Law

A handful of states have very few (or no) charitable gift annuity regulations.  Too often, organizations in the “easy” states operate on the assumption that their CGA programs are essentially unregulated.  While that may seem like a convenient way to escape the rigorous CGA laws of a state like California, it is also an invitation to enforcement action.  A charity transacting business with an out-of-state donor needs to follow the laws applicable in the donor’s location.  States regulate CGAs for the protection of their own citizens.  A charity based in another state ignores such enactments at its own peril.  The state laws can be quite burdensome, both in terms of initial “licensing” to offer annuities and required investment policies and annual reporting.

Paying Higher Charitable Gift Annuity Rates

Virtually all charities peg charitable gift annuity rates to those recommended by the American Council on Gift Annuities (ACGA).  These rates are lower than those available in the commercial annuity market, to maximize the chance that there will be a significant sum left for the charity at the time of the donor’s death.

When a donor approaches a charity and offers to buy a large annuity if the organization will “bump” the rate a point or two above the ACGA recommendation, the temptation to do so is overwhelming.  We believe that such a concession is a mistake, even on a one-time basis.  There are at least three reasons for this:

1. Rate competition poisons the CGA marketplace. Gift annuities are, as the name implies, donations.  If charities started “rate wars,” smaller CGA-issuing charities unable to match the higher payouts might leave the market.  That is certainly not the intent of CGA-related legislation.
2. On the federal level, rate-hiking has the potential to transform a gift annuity contract into the illegal sale of a regulated financial product. Repeated rate-hiking would only compound that problem and almost certainly lead to the “residuum” of the annuity qualifying as (taxable) unrelated business income for the charity.
3. Gift annuities providing in-excess-of-ACGA rates may well not qualify for the beneficial tax treatment afforded to CGAs.  In that case, the instruments would become illegal securities or insurance policies, subjecting the issuing charity to nightmarish consequences and the donor to an unforeseen and unwelcome financial outcome.

Accepting Real Estate to Fund Charitable Gift Annuities

More often than most charities realize, gifts of real estate are often in the equine family — Trojan horses. The reasons for caution when real estate is the “gift” part of a charitable gift annuity may almost be too obvious to belabor.  The issuing organization is accepting an asset that:

1. Produces no revenue until sold;
2. Will likely generate tax bills and other fees until sale;
3. May well have maintenance and repair issues before sale; and
4. Is subject to fluctuating marketplace values.

Then, on top of all that, the charity must start, and continue, making payments to the donor based upon a previously agreed valuation.

Mortgaged Real Estate and Charitable Gift Annuities

An annuity funded by mortgaged real estate is subject to the listed cautions as well as two others:

1. In most cases, the charity will have to start making mortgage payments at the same time it is making annuity payments. It may be possible to avoid that problem by having the donor agree to a deferred start date for the annuity.  (Note: using real estate to fund a deferred annuity may contravene the law of certain states.)
2. In certain circumstances, a charity’s acceptance and subsequent sale of mortgaged real estate can lead to taxable unrelated business income. In the case of charitable gift annuity for real estate, that situation would seriously impair, if not destroy, any benefit the charity might have expected from the “gift” part of the arrangement.

Overenthusiastic Advertising

Only a fundraising ostrich would think that state regulators do not access and examine fundraising letters, advertisements, and web pages.  Gift planners know that donors look at CGAs both as investments and contributions, frequently in that order.  That can lead to an overemphasis on donor financial benefit in promotional materials.  In the worst-case scenario, such a lopsided advertisement could become Exhibit A in an enforcement action against the charity.

The situation would be even worse if the organization was promising higher-than-ACGA-rates or “guaranteed minimum” payouts, either or both of which would make the charitable gift annuity look dangerously like a commercial annuity.