On September 20, 2023, the Federal Reserve decided to keep the federal funds rate steady for the fourth quarter of 2023. While the future is always uncertain, investors and consumers generally believe higher rates will be the reality for the near future. Interest rates are at a 15-year high, affecting loan and credit card rates, corporate and Treasury bond yields, and the stock market.
What is a split interest charitable gift
The interest rate also affects charitable giving. The charitable deduction for contributions to split-interest charitable gifts is determined, in part, by interest rates. A split-interest gift occurs when a donor splits a charitable gift between one or more private beneficiaries and one or more charitable beneficiaries.
Examples of split-interest gifts include:
Charitable lead trusts (CLT)
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- Charitable remainder trusts (CRT)
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- Charitable gift annuities (CGA)
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- Pooled income funds
For instance, a charitable remainder unitrust (CRUT) pays a private beneficiary a percentage of its assets at least annually for the beneficiary’s life or term of years. At the end of the beneficiary’s life or end of the term, the remaining gift goes to charity.
The donor to a split-interest receives a partial charitable deduction for the projected amount that goes to charity. The charitable deduction is based on: the value of the gift, the type of split-interest, the age of the private beneficiaries and/or the term in years (as applicable), and the IRS 7520 rate.
The IRS calculates the 7520 rate as 120% of the applicable federal midterm rate (compounded annually) for the month in which the valuation date falls. The IRS adjusts its rates with the federal funds rate. Think of the 7520 rate as the split-interest’s earnings rate. The IRS publishes the 7520 rate monthly on its website.
Scenarios of a split interest charitable gift
Here are some scenarios created to illustrate the relationship between the type of split-interest gift, the 7520 rate and the charitable deduction:
Scenario 1
Assume a 60-year-old donor wishes to fund a charitable remainder annuity trust (CRAT) with $1 million, a 5% payout paid quarterly to himself, and a 15-year term. After the term, the remainder will go to charity.
Compare the charitable deduction if the donor gave in September 2021, 2022, or 2023 using the 7520 rates in effect:
| Month/Year | 7520 Rate | Charitable deduction |
|---|---|---|
| September 2023 | 5.0% | $471,364 |
| September 2022 | 3.6% | $420,541 |
| September 2021 | 1.0% | $314,285 |
With a CRAT, as the 7520 rate rises, the gift earns more over time, and, theoretically, more will be left to the charitable remainder. Therefore, the charitable deduction increases as interest rates increase. As the scenario illustrates, if the donor delayed a split interest gift from September 2022 for a year, the charitable deduction was increased by about $50,000.
The relationship between interest rates and charitable deductions is the same with a CRUT but interest rates have a far less effect on the deduction with a unitrust versus an annuity.
Scenario 2
Now assume the 60-year-old donor funds a grantor charitable lead trust (GCLAT) with $1 million and a 5% payout paid quarterly to charity for 15 years. After the term, he will receive the remainder.
Using the same months and rates above, the charitable deduction is:
| Month/Year | 7520 Rate | Charitable deduction |
|---|---|---|
| September 2023 | 5.0% | $528,636 |
| September 2022 | 3.6% | $579,459 |
| September 2021 | 1.0% | $685,715 |
With a GCLAT, as the 7520 rate rises, the gift earns more over time, and, theoretically, more will be left to the donor. Therefore, the charitable deduction decreases as interest rates rise. If the donor delayed a split interest gift from September 2022 for a year, the charitable deduction was decreased by about $50,000.
CRAT and GCLAT deduction comparison
Should a donor delay a split-interest gift until 2024 under the assumption the Federal Reserve will reduce interest rates? Using the gift examples above, assume the donor predicts interest rates will fall and the 7520 rate will be 4.4%. The charitable deduction for a gift to a CRAT or GCLAT this year versus next year will be:
| Month/Year | 7520 Rate | CRAT deduction | GCLAT deduction |
|---|---|---|---|
| September 2023 | 5.0% | $471,364 | $528,636 |
| September 2024 (proj.) | 4.4% | $450,445 | $540,688 |
By waiting one year, the donor receives a smaller charitable deduction of $21,000 for a gift to a CRAT. However, if the donor chooses a GCLAT, the charitable deduction increases by $12,000. If the donor’s goal is to maximize his charitable deduction, contributing to a GCLAT in September 2024 achieves that goal.
Other factors to consider beyond the charitable deduction
The size of the charitable deduction is only one consideration when choosing the type and timing of a split-interest gift. The donor should also evaluate estate and gift tax effects, the private beneficiary’s need for an income stream, and the donor’s current and projected taxable income, among other considerations.
For example, assume the donor has his heart set on a CRAT and expects a windfall event in 2024, such as the exercise of stock options. In this scenario, the donor should consider the lower 2024 charitable deduction to offset the windfall income in 2024.
Higher interest rates appear to be here for at least a year, but economic conditions change and interest rates with them. Donors and advisors considering split-interest gifts should take both steady and falling interest rates into account when considering these gifts. One thing that can be said with certainty though is any time is a good time for charitable giving.
