There are many kinds of annuities, and some of them, such as fixed immediate annuities, are well worth exploring, as they can deliver much-needed income to you during retirement. One kind of annuity -- the charitable gift annuity -- can serve another terrific purpose besides generating income for you: It can enrich a non-profit organization you would like to support.
The kinds of annuities you usually hear about are immediate or deferred (paying you immediately vs. starting at some point when you're older), fixed or variable (certain payouts vs. payouts tied to the performance of the market or part of the market), lifetime or fixed period (paying until death or paying for a certain span of time), and so on.
These annuities are contracts -- between you and an insurance company. You pay the company a lump sum (or installments), and in return you receive payments -- now or later.
The charitable gift annuity
So what's different with a charitable gift annuity? Well, it's also a contract, but one you make with a non-profit organization, such as your alma mater or a beloved charity. You (with or without a spouse) give the charity a big lump of cash (or stocks, real estate, or other assets) and in return, you receive a fixed stream of payments for the rest of your life or lives. The size of your payments depend on how old you are when you set up the annuity. If you're relatively young and likely to collect a lot of payments, they will be smaller.
There's another key difference: You may be able to claim a partial charitable tax deduction for the year in which you set up the annuity. It's partial because the IRS views part of your gift as being used immediately by the charity for its tax-deductible good works and the other part as an investment for you that will serve to generate your payments.
One more tax boon: If you donate appreciated stock, you're also reducing your tax bill by no longer having those assets on which you would otherwise eventually be taxed. Your annuity income, though, is partly taxable, as is most annuity income. (Actually, the taxes with such charitable gifts can get a little tricky, and various rules are different depending on your state of residence, so consider consulting a tax pro or financial planner about them.)
If you compare the charitable gift annuity with a regular annuity, you'll find that many nonprofits offer compelling payouts, quite competitive with insurance companies. Also, while you need to seek out insurers with high credit ratings when you buy regular annuities, you should also consider the financial health of the nonprofit. Many, such as established universities, are quite solid.
A drawback with charitable gift annuities is that you're not likely to get any inflation protection with them. With a regular annuity, you can often pay extra (or receive smaller payouts) in exchange for having payments adjusted for inflation. This can be important if you're going to receive payments for 20 years or longer, as a $1,000 annuity check two decades from now will have less purchasing power then than it does today.
An alternative: the charitable remainder trust
A somewhat different option if you want to support a non-profit and also collect income is to make a charitable remainder trust. In a nutshell, you give the charity a lump sum that's put into an irrevocable trust, with you receiving a set percentage of the trust's value, such as 5%, annually. Whenever you die, whatever is left will belong to the charity.
Don't assume that you'll receive 20 installments of 5%, leaving the charity with nothing, because that's not how the math works. If the trust begins with a value of $100,000, you might collect 5% in the first year ($5,000) -- but that leaves $95,000 in the fund. The next year, 5% of $95,000 will give you a $4,750 payment -- leaving $90,250. You see how the payments to you are shrinking. It probably won't be this dramatic, though, because your assets will be invested. And if they grow by more than 5% annually, the fund value and your 5% checks will grow. If they grow by less, you'll still do better than if they don't grow at all.
This is a particularly good option for those with significantly appreciated stock. It doesn't limit you to one charity, either, as you can set up such a trust through various financial institutions, listing several charities as ultimate beneficiaries.
What to do
Give both of the options above some consideration as you plan for your retirement. Annuities, particularly fixed ones, make a lot of sense for many of us. Just shop carefully, assessing fees, the financial strength of the issuer, and the terms involved.
A charitable gift annuity is compelling and can offer payments competitive with insurers -- and it even offers a silver lining to an unfavorable scenario: If you die young, before collecting much of the annuity, it's not an insurer that gets to keep more of your money, but a non-profit you strongly believe in.
Longtime Fool specialist Selena Maranjian, whom you can follow on Twitter, owns no shares of any company mentioned in this article. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.