(My monthly column, originally published March 6, 2016 in the Business section of The News Tribune.)
By Gary Brooks, CFP®
Many smart investors think that today’s historically low interest rate environment will be around awhile. As a result, one of the difficulties for retirement savers is likely to be generating sufficient income from bonds. Bonds have been great contributors to a diversified investment portfolio over the past 30-plus years. But conditions for bond returns are now less favorable.
It’s possible that we’re entering a multi-decade malaise for bond returns similar to the period from the 1940s through 1960s where both government and corporate bonds struggled to post returns better than 3 percent per year for a generation.
If this is to be the case again, investors have some alternatives. You can choose to accept more risk by investing in higher-yielding but lower-credit-quality bonds, longer-term bonds, or stocks with attractive dividends. All of these options increase risk, however, which could lead to a higher possibility of a bad investment outcome.
For the more risk averse, an alternative exists that can deliver more certainty of income, valuable tax benefits and community or social good. Particularly for current retirees, a charitable gift annuity (CGA) can be a compelling substitute to bond investments to help achieve a desired standard of living in retirement.
GIVING WHILE LIVING
A charitable gift annuity is a contract between you and a nonprofit organization. Your gift is accepted in return for a lifetime stream of payments to you. Any remainder is kept by the nonprofit organization.
The gift annuity can create a win-win proposition. Your retirement income may improve and you get a social return on your investment by helping a charity.
At the end of February, the 10-year U.S. Treasury bond paid just 1.7 percent. The broader Barclays U.S. Aggregate Bond Index had an income yield of 2.27 percent. Alternatively, the American Council on Gift Annuities (ACGA) suggested a payout rate of 4.7 percent on a charitable gift annuity for a 65-year-old. The ACGA rate for a 70-year-old was 5.1 percent. The older the person, the higher the payout. Spread the payment over two lives and the rates decline fractionally.
The annuity income does not grow to offset inflation. Over time, the prospects for bonds may improve compared with an annuity. But a CGA has a long list of benefits to consider.
A gift annuity transfers investment risk to the sponsor of the annuity. The investor relies on the full faith and credit off the sponsor to complete the contract. Another less commonly recognized reduction of risk applies because you don’t have to choose your investments any more so you’ve reduced the possibility of making a mistake in search of the best investment.
The tax benefits of the gift annuity can come in many forms. You receive a charitable income tax deduction related to the amount of your gift. If you donate an asset that currently has an unrealized capital gain you can eliminate the need to pay the capital gains tax by gifting the asset. Part of the annuity income is paid to you tax-free as return of your principal. The remainder can be a mix of capital gain income and ordinary income. And if your net worth has you above the threshold for estate tax ($2 million in Washington state), your net worth is reduced by the amount of the gift, lowering estate taxes.
A charitable gift annuity could also provide protection against a growing risk — longevity. Since the annuity can be structured for a lifetime payout, if you outlive your life expectancy it will keep paying you. Partly because of this longevity protection, research in the Journal of Financial Planning demonstrated that investment approaches that combined stocks and income annuities instead of bonds can produce higher probability of funding retirement income needs.
SUPPORTING PREFERED CAUSES OR ORGANIZATIONS
Many nonprofit organizations offer charitable gift annuities directly. Community foundations also provide a compelling alternative if you are not set on gifting assets to any specific organization. (Full disclosure, I am a member of the board of directors of the Greater Tacoma Community Foundation).
The community betterment or social good that your gift can provided makes the charitable gift annuity more compelling than standard income annuities from an insurance company.
This is not a strategy that applies to everyone, but in cases where investment management, retirement income, and charitable intent overlap, it can be a useful tool. There are other vehicles for giving that provide investment benefits to the donor and the organization, so it’s important to understand your choices. Speak to a gift officer at your preferred nonprofit organization. Together, the gift officer, your accountant and your financial adviser can help you design a CGA that fits your preferences.
Gary Brooks is a certified financial planner and the president of Brooks, Hughes & Jones, a registered investment adviser in Gig Harbor. Reach him at bhjadvisors.com.