E.3. Deferred Gifts Spring 1992 Development Policy and Administration Manual Chapter IV. Gift Administration Procedures Section E. Pledges, Bequests, and Deferred Gifts ************************************************************* DEFERRED GIFTS The term "deferred gifts" covers a class of gifts that share a common characteristic: the gift is divided into a present interest and a future interest, and the donor irrevocably gives one interest but either personally retains the other interest or retains it for another beneficiary. For this reason, the gift is sometimes referred to as a split-interest gift. The term deferred gift historically arose because, in the most common forms of this type, the donor retains the present interest and gives the future interest to charity. However, this is not always true (for the most obvious example see "Charitable Lead Trusts", below), and in any case the donor has not deferred making a gift, but has only deferred the time when the University may enjoy the benefit of the gift. For this reason, the term planned gifts is frequently used. Deferred Giving Vehicles The Internal Revenue Code recognizes various basic types of deferred gift vehicles, of which The Regents currently accept the following: charitable remainder annuity trusts; charitable remainder unitrusts; pooled income funds; and charitable lead trusts. Another vehicle, not technically a deferred gift, is the charitable gift annuity, a contract entered by a charitable organization and a donor to provide a lifetime annuity for up to two persons, in exchange for a current gift. On approval from the California State Insurance Commission, expected in 1992, The Regents, in exchange for current gifts, will enter into charitable gift annuity contracts for immediate and deferred charitable gift annuities (see discussion on page 166). Before acceptance by The Regents, provisions of a proposed trust are to be submitted to Development Policy and Administration, Office of the President, which will coordinate review of the trust terms with the Treasurer's Office and General Counsel. Text for pooled income fund agreements and charitable gift annuity contracts are provided by Development Policy and Administration. Charitable Remainder Annuity Trust A charitable remainder annuity trust is created when cash or securities (or, in exceptional cases, income-producing, debt-free real property) is irrevocably transferred from the donor to a trustee in return for a guaranty that named beneficiaries will receive at least annually a fixed-dollar amount established at the time of the transfer of assets. This fixed amount must be at least five percent of the fair market value of the trust assets at the time of transfer, and must be paid from principal if earned income does not reach a level at least equivalent to the guaranteed annuity. Any excess income over the required annuity payment to the beneficiaries is returned to the trust principal for reinvestment. The donor receives a charitable income tax deduction equal to the value of the remainder interest and, if the trust is funded with appreciated property or securities, the donor avoids all tax on capital gains (although the appreciation is a preference item for purposes of the alternative minimum tax). No formal minimum amount is required to establish a charitable remainder annuity trust. For gifts to The Regents a minimum guideline of $50,000 has generally been used, although, depending on the circumstances of the gift, a larger or smaller amount may be appropriate. Once an annuity trust has been established, no additional gifts may be made to the trust; it is possible, however, to establish additional annuity trusts. Charitable remainder annuity trust assets may be pooled with other assets for investment purposes. An annuity trust may be established for the lifetimes of one or more individuals, or for a fixed term not to exceed twenty years. Payments from the trust may continue to a beneficiary after the donor is deceased, but may not continue beyond the lives of the originally named beneficiaries, all of whom must be living when the trust is established. Charitable remainder annuity trusts are valued by the University for reporting purposes at the amount of cash or the market value of other assets at the time they are received, unless it is anticipated that the principal will be invaded to meet the payout obligation, in which case the gift should be reported at its estimated net realizable value. Charitable Remainder Unitrust A charitable remainder unitrust is identical to a charitable remainder annuity trust, except that payments to beneficiaries are based on a fixed percentage (not less than five percent) of the market value of the trust as calculated on the valuation date(s). For purposes of calculating the payment to the beneficiary, the fair market value of the trust is redetermined at least annually. Unlike annuity trusts, the payments from unitrusts may therefore increase (or decrease) over time, potentially providing a hedge against inflation. Also unlike annuity trusts, a unitrust is permitted to receive additional contributions. As with annuity trusts, unitrust assets may be pooled with other assets for investment purposes. The donor receives a charitable income tax deduction equal to the value of the remainder interest and, if the trust is funded with appreciated real property or securities, the donor avoids all tax on capital gains (although the appreciation is a preference item for purposes of the alternative minimum tax). As with annuity trusts, there is no formal minimum gift required, although the same guideline of $50,000 has generally been used, depending on the circumstances of the gift. A unitrust's earnings may be less than the prescribed percentage of the market value of the trust assets. In this case, one of several things may happen. If the trust is not a net income unitrust and income is insufficient, the principal will be invaded to make the payments to the beneficiaries. In the case of net income unitrusts, however, only the net income is paid to the beneficiaries; the principal remains inviolate. Depending on the trust's terms, the income payout for subsequent years may exceed the fixed percentage stated in the trust agreement in order to compensate for any deficiencies from prior years in which the trust earned less than the stated percentage (called a "makeup provision"), or there may be no provision for recovery of the shortfall in subsequent years. For all charitable remainder unitrusts, regardless of type, any excess income earned over the stipulated payout is returned to the trust principal for reinvestment. As with an annuity trust, a unitrust may be established for the lives of one or more individuals, or for a fixed term not to exceed twenty years. Payments from a unitrust may continue to a beneficiary after the donor is deceased, but may not continue beyond the lives of the originally named beneficiaries, all of whom must be living at the time the trust is established. Charitable remainder unitrusts, like charitable remainder annuity trusts, are valued by the University for reporting purposes at the amount of cash or the market value of property or securities at the time the assets are received. Pooled Income Funds Pooled income funds resemble charitable remainder trusts in that assets are given irrevocably to the University in trust, and the donor or other designated beneficiary retains a life interest in the income earned on the gift. Pooled income funds also resemble mutual funds, in that the income generated by a pooled fund is paid on a prorated basis to all the participants in the pool. At present, the University offers two funds: the UC Long-Term Income Fund and the UC Balanced Growth Fund. Brochures fully describing the funds and the text for agreements are available from the Development Policy and Administration Office, Office of the President. Donors' gifts to pooled income funds are held for investment purposes in one pool, which functions similarly to a mutual fund. When a donor makes a gift to the fund, units are assigned to the named beneficiaries based on the market value of the gift. The income from the pool is then prorated and paid periodically to each beneficiary on the basis of the number of units assigned. Because the fund's entire income must be distributed each year, the income stream to the donor is potentially greater (or less) than is the case with a charitable remainder trust. (Capital gains are not distributed to donors but are retained by the pool.) Because of different investment criteria, and because certain management costs are avoided, smaller gifts may be more appro- priate for pooled income funds than for charitable remainder trusts. The minimum gift to enroll in one of the University's pooled income funds is $5,000, with additions of as little as $1,000 accepted. Cash or marketable, taxable securities can be donated; gifts of tax-exempt securities cannot be accepted because they would disqualify the pool. By the same token, a check drawn on a tax- exempt money fund should not be accepted. In unusual cases, gifts of real property and closely held stock may be accepted with approval from the Office of the President. However, because the pool would assume liability from the donor for short-term capital gains taxes, the University will not normally accept into the pooled income funds securities that have been held for less than the minimum long-term capital gains holding period. To avoid delay of deposits into the fund, securities should be sent directly to the Treasurer of The Regents. If there is anything unusual about the securities, the Treasurer's Office should be consulted beforehand. The donor receives a charitable income tax deduction equal to the value of the remainder interest and, if the donor gives securities, all tax on capital gains is avoided (although the appreciation is a preference item for purposes of the alternative minimum tax). Pooled income fund gifts are valued by the University for report- ing purposes at the amount of cash or the market value of securi- ties when the assets are received. Charitable Lead Trust A charitable lead trust is the "mirror image" of a charitable remainder trust and, as with remainder trusts, may be structured either as an annuity trust or as a unitrust. A charitable lead trust is established when assets are transferred to a trustee, with instructions to make designated payments to the University for a specified period, invading principal if necessary. On termination of the trust, assets either revert to the donor or pass to the noncharitable beneficiary named by the donor. Charitable lead trusts may, therefore, be especially useful for estate planning purposes. No gift should be reported for the transfer of the corpus of a charitable lead trust, nor should an estimate be made of the present value of the income interest. Rather, income from charitable lead trusts should be reported as a gift in each year income is received. Donations Sometimes Classified as Deferred Gifts Some donations are considered deferred gifts under certain circumstances: charitable gift annuities; real property, if the donor retains a life interest in the property; life insurance, if premiums will be paid to maintain the policy rather than surrendering the policy for cash; installment bargain sales; and externally held trusts, if they are charitable remainder or charitable lead trusts. Charitable Gift Annuity Note: The Regents have applied to the California Insurance Commission to issue charitable gift annuities. Approval is expected in 1992. Charitable gift annuities resemble commercial annuities issued by insurance companies, except that the annuitant (donor) tenders a greater sum of money (the "gift" portion of the transaction) and in turn receives a partial charitable income tax deduction for the gift. The charity agrees to pay the donor (or another annuitant) a fixed sum of money annually, usually for the remainder of that person's life. The charitable gift annuity resembles a charitable remainder annuity trust in that the annuitant receives a fixed payment, except for the following significant differences: - a charitable gift annuity is a general obligation of the charity; a charitable remainder annuity trust is backed only by the portfolio of the trust, and therefore if the trust is exhausted, the annuity ceases; - for the initial years of a gift annuity (until the donor has surpassed his or her lifeexpectancy) part of the payment of a gift annuity is regarded as a return of principal and is therefore tax free; payments received from an annuity trust are often fully taxable as ordinary income; and - it is feasible to accept much smaller amounts for gift annuities than for charitable remainder annuity trusts. Real Property with a Retained Life Interest Donors may give a remainder interest in a personal residence or farm and receive an immediate charitable income tax deduction, while enjoying the use of the property for the rest of their lives or for a specified number of years. These gifts may be especially attractive to donors on fixed incomes whose houses may have appreciated substantially in value, because capital gains are avoided (although the appreciation is a preference item for purposes of the alternative minimum tax) while a large income tax deduction is usually generated. A personal residence qualifies as a gift even if it is not the donor's primary residence (e.g., a vacation home). The furnish- ings, unless they are fixtures, are by definition not included in the gift of the residence. Donors may not receive an income tax deduction on a gift of a future interest in the furnishings. A gift of a farm also qualifies. A farm is defined as land that is used for the production of crops, fruits, or agricultural products, or for the sustenance of livestock. The donor need not make a gift of the entire farm; any portion of the acreage used as a farm may be given. The donor makes the gift by executing a new deed to the property. When a gift of a remainder interest in a residence or farm is proposed, it must be determined in advance who will pay for taxes and other costs of maintaining the property. See Section IV: D.2 for more information about gifts of real property. Life Insurance When a life insurance policy is given, it may be surrendered immediately for its cash value, or it may be maintained, in which case it is considered a deferred gift. For more information, see Section IV: D.5, Life Insurance, and Section IV: C, General Information About Noncash Gifts. Installment Bargain Sale An installment bargain sale occurs when the University makes at least one payment on the property in a year after the year in which the sale is made. The installment sale permits the donor's cash flow (and taxable gain) to be spread over several years. (For more information on bargain sales see Section IV: D.7). Externally-Held Trusts Trusts may be administered by a charitable organization, such as the University or one of the Campus Foundations, or by another individual, bank, or trust company. Externally-held trusts refer to those not administered by the University or a Campus Foundation. For more information, see Section III: F.1.