Author:
JOEL M. BREITSTEIN, ATTORNEY
JOEL M.
BREITSTEIN is an attorney who specializes in charitable gift planning and
philanthropic resource development. He is also the Director of Philanthropic
Resource Development for the
This article examines the use of life insurance in charitable giving,
including a unique strategy that enables a donor to use life insurance as a current
gift-giving vehicle through which a charity can receive a
substantial current cash benefit.
Life insurance is traditional fare on the menu of
planned gifts. Making a gift of a life insurance policy to one's favorite charity appeals
to a variety of donors because it is a flexible, cost-effective, and in many
cases tax-advantaged way to make a major gift that will benefit the nonprofit
institution after the donor dies. Life insurance can also be used as an
asset-replacement strategy. Under this strategy, a donor makes a gift of an
asset (such as real estate or appreciated securities) to the nonprofit and
replaces the value of that asset to benefit his/her heirs with a life insurance policy
owned in a way that eliminates estate taxes on the benefit that inures to the
donor's heirs.
There are two
basic ways to make a gift of life insurance: an irrevocable gift of a new or
existing policy where the donor gives up all incidents of ownership, or by
naming the nonprofit organization as the outright or contingent beneficiary of
a policy. Each approach has advantages and disadvantages.
Irrevocable gift of an existing policy. If a donor owns
excess life
insurance
(perhaps purchased for a reason that no longer exists), he, she or it (if a
corporation) might consider making an irrevocable gift of the policy to a charity. If
complete ownership is transferred to the nonprofit and the charity is named
as the beneficiary, the gift will generate a charitable income tax deduction.
If the policy
is "paid up" (i.e., no premiums remain to be paid), the deduction is
generally equal to the policy's replacement value or the donor's basis, if the replacement
value exceeds the basis. If premiums remain unpaid on the policy, the deduction
can be calculated based on the policy's interpolated terminal reserve value—a
value that might be slightly in excess of its cash surrender value. If the
donor continues to pay the premiums on the policy (either directly to the insurance company
or as a gift to the nonprofit organization that pays the premium), each such
payment is tax deductible as a charitable gift. If the cash surrender value—or,
in the case of a paid-up policy, its replacement value—exceeds $5,000, the
donor must seek an independent appraisal and file a Form 8283 with his/her tax
return. 1
Irrevocable gift of a new policy. A donor may take out
a new policy and irrevocably name the nonprofit organization as the owner and
the beneficiary of the insurance contract. This can be an attractive strategy
for a younger donor, because the premium cost is usually low compared with the
ultimate death benefit that will accrue to the charity upon the donor's death.
Whether the donor makes one single premium payment for the policy or pays
premiums annually, each payment produces a charitable income tax deduction.
To maximize
the tax advantage of this gift, the donor should consider making annual gifts
of appreciated securities to the nonprofit organization, which will then make
the premium payment. This will produce a charitable deduction based on the fair
market value of the gift of the securities on the date the stock is transferred
to the charity,
and all capital gains tax that would have been paid had the securities been
sold, will be avoided.
Pros and cons of an irrevocable gift of life insurance. The primary benefit
to the donor of making an irrevocable gift of the policy to the nonprofit is
the charitable deduction that results for the value of the policy on the date
of the gift and for each subsequent insurance premium that is paid. The downside
is that the gift is irrevocable—the donor can't take it back. Nevertheless, if
there are premiums to be paid, the donor always has the option to discontinue
paying those premiums; but the nonprofit, as owner of the policy, has the right
to (1) continue making the payments, (2) take advantage of a cash surrender option
(if there is any cash value in the policy), or (as discussed later) (3) seek a life settlement
solution.
Naming the charity as a primary or contingent beneficiary. If the donor wants to
retain maximum flexibility, the charity can be named as either the primary
or contingent beneficiary of the policy. This will not produce an income tax
charitable deduction for the payment of future premiums on the policy, but it
does afford the donor a full estate tax charitable deduction 2 when the donor dies.
The concept of naming one's favorite charity as a contingent beneficiary of a
policy could be a good strategy for a childless married individual who wants to
assure maximum protection for his or her spouse while both spouses are alive,
yet wants to provide a benefit to the charity if the primary beneficiary
predeceases the insured or both perish in a common disaster.
As part of a comprehensive
philanthropic, estate and financial plan, it might be more advantageous to
donate a highly appreciated asset to a charitable organization, because the
donor will usually be able to take a charitable deduction for the fair market
or appraised value of the asset. Once the asset is in the hands of the charity, there
will be no capital gains tax on the subsequent sale. The donor, in effect, gets
a double benefit—a substantial deduction and elimination of the capital
gains tax. The charity
receives its benefit when it might be most beneficial rather than having to
wait until the donor dies. However, the loser in such an arrangement may be the
donor's heirs because the asset will no longer be available for inheritance.
This is where life
insurance
can play an important role.
The donor can
purchase a life
insurance
policy and irrevocably either (1) name an heir or heirs as the owners or (2)
create a special trust that will become the owner of the life insurance
contract. The insured might use the tax savings from the charitable gift to
purchase a single premium policy or choose to pay premiums annually. In either
case, if the policy is irrevocably owned by either a trust or some third party(ies) outside the insured's
estate, the eventual death benefit will pass tax-free to the named
beneficiaries. 3 When the insured
makes the premium payments on a policy that is owned by another, whether or not
it is in trust, there may be gift tax consequences. Therefore, as with any
estate, tax, or financial planning matter, the insured should seek the advice
and counsel of his or her tax planning professional.
This strategy
has been popular when coupled with a charitable remainder trust (CRT) 4 that pays the donor
and spouse an income for life; at the death of the last income beneficiary, the
remainder goes to charity.
Using the same concept, the donor can (1) make a gift of a highly appreciated
asset to the CRT, (2) generate a charitable income tax deduction for the
present value of the gift that will ultimately go to the charity, 5 (3) avoid the capital
gains tax on the asset when it is sold inside the trust, and (4) secure a new
source of income for life.
The wealth-replacement strategy can be overlaid to provide for heirs who would
have received the asset but for the charitable plan.
Life insurance has traditionally been used as a
deferred gift for the benefit of charity or as a wealth-replacement strategy
for other assets that may have been gifted to a charity. But what if the charity is in the
midst of a capital or endowment campaign and needs current dollars? What if it
owns life
insurance
contracts on some of its donors and would like to turn a future asset into a
current asset? Or, what if a donor does not choose to make a gift of
securities or other assets he/she might own, but has excess life insurance that
was purchased for a need that no longer exists? Could that life insurance policy
be used to generate a substantial current benefit for charity and,
perhaps, a deferred benefit as well?
The concept
of a life
settlement is not new. Simply put, it is the sale of an "in-force" life insurance policy
by the policy's legal owner to a third party when the insured is not deemed to
have a terminal illness. In most cases, to qualify for a life settlement
offer, the named insured must be at least 65 years old. Other criteria, such as
age above 65, health condition, and premium structure, are factors that will
determine the amount that a company will offer. Because this is not a surrender
of the policy for its cash value to the insurance company that issued the policy, it
does not matter whether there is any cash value at all in the contract. If an
offer is made on a particular policy that has a cash surrender value, the offer
usually far exceeds the cash accrued in the policy.
Example 1. A small college is the owner and beneficiary
of a $500,000 life
insurance
policy given by an alumnus. The donor made the gift of the new whole life policy when
he was age 65. Each year, over and above his gift to the annual fund, the donor
makes a gift to his college to cover the cost of the premium on the policy. The
donor is now 75.
The college
is in a financial crunch and needs to generate cash to cover the costs of
capital improvements to the campus. However, it is also looking to its
long-term future and to growing its endowment for which the donor made the gift
of the life
insurance
policy. The Director of Planned Giving meets with the donor and suggests a way
to solve the immediate needs of the college while being mindful of its
longer-term needs.
Example 2. The same college offers a charitable gift
annuity program to encourage its more senior alumni, who might need additional
current income, to make a planned gift that meets that objective while helping
the institution build its endowment fund. Traditionally, donors have made gifts
of cash, appreciated securities, and real estate to fund a charitable gift
annuity.
In the course
of a meeting with a 75-year-old prospective donor, the college's planned giving
officer learns that the donor wants to increase his annual income and is
interested in a charitable gift annuity. Although the alumnus has already
divested almost all his appreciated securities, he does own a life insurance policy
that is no longer needed and, in fact, the insured does not want to continue
paying the premiums on the policy. How could a life settlement help the college
secure a much needed charitable gift and meet the donor's need for more income?
The use of life insurance as a
charitable gift doesn't have to be just another bland item on the menu of
charitable gift planning strategies. There are many ways to "spice it
up" to suit the changing needs of the nonprofit organization and a donor's
planning palate. Most donors and nonprofit organizations think of life insurance only as
an asset that produces a future benefit for the nonprofit organization.
However, by using the wealth-replacement strategy and/or the life settlement
solution to meet the needs of the donor's family and the nonprofit,
charitably inclined individuals can truly get the most out of life.
See Reg.
1.170A-13(c) .
See Section
2055 .
See Section
2042 .
See Section
664 .
See Section
170(f)(2)(A) .
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