This is the actual text from §25.7520-3(b)(2)(v). Click on this link to see further information behind the calculation used in Example 5.
Reg. §25.7520-3(b)(2)(v), Example 5
Eroding corpus in an annuity trust. The donor, who is age 60 and in normal health, transfers property worth $1,000,000 to a trust. The trust will pay a 10 percent ($100,000 per year) annuity to a charitable organization for the life of the donor, and the remainder is to be distributed to the donor’s child. The §7520 rate for the month of the transfer is 6.8 percent. Because the 10 percent annuity payout rate exceeds the 6.8 percent income and growth rate that the trust is expected to experience each year, the annuity payout must be assumed to progressively erode the corpus. Using an interest rate of 6.8 percent, an annuity payout of $100,000 per year will exhaust a $1,000,000 trust corpus in 18 years. The final payment at the end of the 18th year will consist of a partial payment of $32,712. Under §7520, the standard life annuity factors are based on the assumption that any person may survive until age 110. This means that the standard life annuity factor for age 60 (9.8585) takes into account the separate probabilities that a person aged 60 may survive to receive each of 50 different annuity payments. However, in the present case, because of the eroding corpus, the person aged 60 can be assumed to receive no more than 17 $100,000 annuity payments, regardless how long that person might survive. Therefore, the standard life annuity factor for a person aged 60 (9.8585) is not applicable in this case, and special §7520 annuity factors that take into account the 18-year limitation on the annuity payout must be used. The special annuity factor for the present value of the right to receive $1.00 per year for 17 years or until the prior death of a person aged 60 survives is 0.1836. The present value of the charitable annuity interest is $867,269 ($100,000 x 8.6121 plus $32,712 x 0.1836).
