David Hohler, John J. Monahan
Protecting Your Gift Annuity Program From Underwater Gifts PDF
An underwater gift annuity occurs when the gift assets are exhausted before the death of the final income beneficiary. Underwater gift annuities are common for charities of all types and sizes, and it's important to understand how to identify and manage these gifts in order to mitigate their financial, regulatory and reputational impact.
Although it is impossible to entirely avoid underwater gifts, understanding what causes a gift to go underwater can help a charity to make informed decisions and implement measures to reduce the risks within their control. Here are some of the key reasons a gift may go underwater:
Accepting unusually large gifts, offering higher payout rates than the American Council on Gift Annuities (ACGA) recommends, withholding some of the charitable portion of the gift for current spending or marketing immediate annuities to young donors may ultimately hurt the program.
The ACGA addresses this longevity risk by implementing a rate-setting methodology that assumes all annuitants are female and one year younger than their actual age. Additional measures, such as setting a minimum age requirement, can also mitigate longevity risk.
This situation is most problematic for new gifts or gifts with long remaining lives. Prudent investment management and diversification through asset allocation can reduce, but not eliminate, market risk for any single annuity.
Obtaining assets that cannot be sold in a timely manner or that are insolvent is risky. When accepting gifts of any asset other than cash, a charity should seek expert advice, such as a qualified appraisal.
Underwater gifts, if identified and managed, do not necessarily spell disaster for a charitable gift annuity program.
Over time, however, the residual value of these other gifts in the pool will decline. Limit specially designated gifts and forgo the residuum of terminated gifts to protect the pool.
This prevents the gift annuity from going further underwater and isolates the impact to the other gifts in the pool, but diverts resources away from current mission-related activities.
If a donor learns that the annuity obligation is harming a charity, they may consider relinquishing their interest income. Furthermore, asking may reaffirm credibility and protect the charity's reputation.
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