Can a commercial annuity be rolled over into a charitable gift annuity?
October 17, 2019 | by Phillip Buchanan
Charitable donors and their advisors occasionally ask whether it is possible to do a “tax-free rollover” or a “1035 exchange” of a commercial annuity for a charitable gift annuity without any tax due on the gain in the commercial annuity. Internal Revenue Code (I.R.C.) section 1035(a)(3) can cause confusion on this subject since it provides that a (tax-free) like-kind exchange can be made with an annuity contract for another annuity contract.
However, I.R.C. section 1035 only applies to a commercial annuity contract for a commercial annuity contract with an insurance company and not for a charitable gift annuity. Under the Philanthropy Protection Act of 1995, charitable gift annuities are not considered insurance under federal law and cannot be issued by an insurance company. Simply put, commercial annuities and charitable gift annuities are apples and oranges, and a tax-free rollover/1035 exchange is not allowed under current law. A lifetime transfer of a commercial annuity (even to a charity like Duke University) will result in tax on any gain to the donor, as well as any applicable surrender charges, the cost of an appraisal and other potential costs.
With a life income gift, such as a charitable gift annuity or charitable remainder trust, the donor's deduction will only be for part of the commercial annuity's value. If the gain in the commercial annuity is substantial, the donor may not be able to eliminate all of the tax liability incurred on the gain if the commercial annuity is cashed out and donated to a charity. See Treasury Reg. section 1.170A-4(a) and Friedman v. Commissioner, 41 TC 428 (1965); Rev. Ruling 69-102, 1969-1 CB 32.
If the donor's gain in the commercial annuity is modest, and the donor decides to use it to make a charitable gift, please note that it is generally far more cost effective and efficient if the commercial annuity is cashed out by the donor and the net cash proceeds are then transferred to charity.
The considerations noted, above, apply to charitable gifts made by a donor during life but not to gifts made through the donor’s estate plan. If a commercial annuity is left to Duke University (or other charity) at the donor’s death, no tax will be due on any gain in the commercial annuity and 100% of the value can go to the charity.
Please consult with your personal advisors to explore whether this – or other charitable gifts – are right for you.