What do rising interest rates mean for charitable giving?
The Charitable Federal Midterm Rate and its impact on your philanthropic plans.
As you’ve likely read in the headlines recently, interest rates are trending upward in response to rising inflation. If your financial plans include a philanthropic component (or you would like them to), you may have wondered how higher interest rates affect charitable planning.
Each month, the Internal Revenue Service (IRS) publishes a charitable discount rate – sometimes referred to as the Charitable Federal Midterm Rate, or the Section 7520 Rate – that is used in calculating the income tax deduction a donor receives for making a “split-interest” gift to charity.
What is a “split-interest” gift?
Charitable gift annuities and charitable remainder unitrusts are characterized as split-interest gifts because they provide a financial benefit to both:
- A non-charitable beneficiary – such as the donor or other loved ones – now, in the form of lifetime payments; and
- A charity, in the future, in the form of remaining assets once the income interest of the non-charitable beneficiary terminates (most commonly, when they pass away).
A donor receives a charitable income tax deduction at the time they establish a split-interest gift. This deduction is an estimate of how much will eventually pass to charity. The IRS requires that the deduction exclude the value of the income stream that the donor (or other income beneficiary) is expected to receive before the charity realizes any benefit. Recognizing that the non-charitable beneficiary will be paid over time, rather than all at once, the IRS “discounts” the value of those future payments by applying the charitable discount rate.
To determine the applicable rate, the IRS uses a formula that is tied to the yield on U.S. treasuries with remaining maturities between 3-9 years.
As a result, as interest rates rise or fall, so too does the charitable discount rate. This dynamic was underscored throughout the pandemic, as historically low interest rates caused the discount rate to fall from 2.2% in early 2020 to an all-time low of 0.4% by August of that year. But by August 2022, the discount rate had climbed to 3.8%, reflecting rising interest rates.
Changes in the charitable discount rate lead to a higher or lower charitable tax deduction for life income gifts, especially charitable gift annuities and other fixed-payment gift vehicles. A lower discount rate reduces the donor’s tax deduction, while a higher discount rate leads to a higher charitable deduction for the donor.
A donor may select the discount rate available in the month of their gift, or the rate from either of the two previous months. Whether to use a higher or lower rate can depend on the donor’s financial goals. If the donor wishes to maximize the charitable deduction in a single taxable year, using the highest available discount rate will usually be most advantageous.
On the other hand, if the donor is establishing a charitable gift annuity and does not plan to itemize charitable deductions in the year of their gift, they might opt to use the lowest discount rate available because doing so will maximize the tax-free portion of each annuity payment they receive over the course of their life expectancy.
If you’d like to explore how rising interest rates may factor into your specific charitable giving plans, please don’t hesitate to contact the Office of Gift Planning at 919-681-0464 or giftplanning@duke.edu.
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