Back to Missives
George F. Bearup, J.D. Senior Legal Trust Advisor

4-Aug-20

Impact of Low Interest Rates on Charitable Giving

Take-Away: While the current low interest rate environment is favorable for many estate planning strategies, the low IRC 7520 rate makes some charitable gifts less desirable than before because the income tax deduction for certain charitable gifts will be dramatically reduced. These low interest rates will impact charitable gift annuities and charitable remainder annuity trusts, but not charitable remainder unitrusts.

Background: A couple of weeks ago we looked at the opportunity to exploit the currently low IRC 7520 interest rate if a remainder interest in a residence or farm is given to a charity, which noted that the lower the IRC 7520 rate at the time of the gift of the remainder interest to the charity, the greater the income tax charitable deduction. Consequently, the gift of a remainder interest in a residence or farm to a charity is a highly effective estate planning strategy.

  • QPRTs, CGAs, and CRATs: However, there are other estate planning techniques that do not fare well in a low interest rate environment. For example, a gift to a qualified personal residence trust (QPRT) is less favorable with low interest rates because the donor is deemed to have retained less, thus leading to a larger taxable gift. The same can be said for charitable gift annuities and charitable remainder annuity trusts.
  • CRUTs Only a charitable remainder unitrust (CRUT)is usually unaffected by interest rate swings, since the beneficiary receives a fixed percentage of the trust corpus’ value, which can go up and down over time, reflective of the prevailing interest rates when the unitrust amount is calculated. In short, the relative values of the unitrust and remainder values will rise and fall together.
  • The following explains why charitable gift annuities (CGA) and charitable remainder annuity trusts (CRATs) are negatively impacted by low interest rates.

Charitable Gift Annuity: As noted previously, the IRC 7520 rate for August, 2020 is 0.04%, which is extremely low. The Tax Code provides that in order for the charity’s gain on the sale of a charitable gift annuity not to be taxed as unrelated business income, the present value of the annuity must be less than 90% of the fair market value of the property that is exchanged for the annuity. [IRC 514(c)(5).] Some gift annuities established by younger donors may not pass this ‘less than 90% of the fair market value’ test. There is a bit of flexibility though: when establishing a charitable gift annuity, the donor can elect to use the IRC 7520 rate from one of the two preceding months or use the month of the transfer’s IRC 7520 rate.

  • 10% Test: The American Council on Gift Annuity Proposed Rates, effective July 1, 2020, results in a charitable income tax deduction of more than 10% if the IRC 7520 rate is 0.6% or higher, whatever the payment frequency of the annuity. If the IRC 7520 rate is less than 0.6%, which it is currently, the charitable income tax deduction will be less than 10% when the annuitants are below certain ages. The actuarial present value of the CGA ‘remainder’ given to the charity must be more than 10% for the gift of the remainder interest to be tax deductible by the donor.
  • Example: The current Council recommended gift annuity rate for a joint and survivor annuity for two persons, both age 60 years, is 3.6%. The annuity is to be paid quarterly. If the current IRC 7520 rate of 0.4% is used, the actuarial value of the charitable remainder is only 7.9%, not more than 10%, which means that there will be no charitable income tax deduction available to the donor.
  • Non-Itemizers: While the charitable income tax deduction on the purchase of a charitable gift annuity is less when the IRC 7520 rate is low, the amount of each annuity payment that is excluded from the recipient’s taxable income will be higher under IRC 72. Therefore, if the individual donor is a non-itemizer who cares more about how much of his/her income is taxable than about maximizing his/her charitable income tax deduction, he/she will find a charitable gift annuity more attractive right now. In this situation, if that is the donor’s goal, he/she should elect to use the lowest available IRC 7520 rate.

Charitable Remainder Annuity Trust (CRAT): Similar to the charitable gift annuity, a very low IRC 7520 rate will dramatically reduce the charitable income tax deduction for transfers to a charitable remainder annuity trust. In addition, the low IRC 7520 rate can also create a couple of tax traps. Under the Tax Code, a qualifying charitable remainder annuity trust (and also a charitable remainder unitrust) the charity must have an actuarial value of at least 10% of the fair market value of the property that is transferred to the trust. As with the CGA, the donor can elect to choose the IRC 7520 rate for the prior two months when forming the CRAT, or use the rate for the month of the transfer. Two separate ‘tests’ must be passed for the trust to be treated as a tax exempt qualified charitable remainder trust.

  • 10% Remainder Test: The 10% value of the charity’s remainder interest test is much more difficult for a CRAT to pass when the IRC 7520 interest rate is low.
  • Example: If the CRAT is created and funded in August when the IRC 7520 rate is 0.4%, a 6% charitable remainder annuity for two individuals, both age 70 years, paying the annuity to them quarterly, will fail the 10% remainder test. Specifically, the actuarial value of the CRAT’s remainder in this example earmarked for the charity is 0%.
  • 5% Exhaustion Test: In addition to the 10% remainder test, a charitable remainder annuity trust also must pass another test that requires that there be no more than a 5% probability that the CRAT will be exhausted before the charitable remainder vests in the charity. Again, this 5% test becomes more difficult to pass when the IRC 7520 rate is low. [This 5% exhaustion test does not apply to a charitable remainder unitrust (CRUT), nor does it apply to a charitable gift annuity (CGA.)] Using the same facts in the prior example, that CRAT would also fail the 5% exhaustion test.
  • Examples of the Impact of a 0.4% IRC 7520 Rate: The impact of the low IRC 7520 rate is revealing when looking at various payout annuity amounts and the age when such a CRAT can legally be created, satisfying both the 10% and 5% tests. Assume that the amount transferred to the CRAT is $100,000 which will be required to make quarter-annual annuity payments to the creator of the CRAT. What follows is the youngest age when the donor can create a CRAT with the annuity payout amount.

Payout Amount                     Youngest Age

$5,000                                              77

$5,500                                              80

$6,000                                              82

$6,500                                              84

$7,000                                              86

$7,500                                              88

$8,000                                              88

$8,500                                              88                                            

Conclusion: There are plenty of estate planning strategies that can make use of the historically low IRC 7520 rate. Strategies like intra-family loans, or refinanced loans at lower rates, installment sales of depressed value assets to family members using the low interest rate, GRATs, private annuities, self-cancelling installment notes, sales to intentionally defective trusts (IDGTs) or as noted earlier, a gift of a remainder interest in a residence or farm to a charity. Conversely, QPRTs, CRATs and CGAs will not be as successful to create large income tax charitable deductions in a low interest rate environment.