Life Insurance and Charitable Giving

Note: This post was originally published in January 2016. The below still has relevant information. For an updated article, please visit Charitable Gifts of Life Insurance

Giving life insurance to a charity may allow you to make a larger gift than you otherwise could afford. Further, the government encourages charitable giving by providing tax advantages for certain charitable donations (the charity must be a qualified charity). This means that both you and the charity could benefit from your donation (though some charities may not accept a gift of life insurance for various reasons).

Typically, a donor makes a charity the owner and beneficiary of some type of permanent life insurance policy. But, there are many ways of structuring a charitable gift involving life insurance, and one alternative may better suit your needs and those of the charity than others.

Caution: This discussion contains only a brief description of some of the many charitable giving strategies involving life insurance. You should consult your tax advisor before making such a gift to make sure it is structured properly. Life insurance products contain fees, such as mortality and expense charges, and may contain restrictions, such as surrender periods. Please keep in mind that the primary reason to purchase a life insurance product is the death benefit.

Name Charity as Beneficiary of Proceeds

This is the simplest type of charitable gift using life insurance. You designate the charity as the beneficiary of your existing policy or a new policy by completing a beneficiary designation form. You own the policy and pay the premiums. Upon your death, the charity receives some or all of the proceeds from the policy.

Advantages and Disadvantages: Designating a charity as beneficiary while retaining ownership of the policy allows you to retain control over and rights to the policy, including the ability to change the beneficiary or access to the policy’s cash value. However, because you retain ownership of the policy, the premium payments you make are not tax deductible for either income tax or gift tax purposes. At your death, the proceeds will be included in your gross estate, however, there is an offsetting estate tax charitable deduction for the amount of proceeds that pass to the charity.

Name Charity as Recipient of Dividends

Another simple way of making a charitable gift is to assign to the charity policy dividends from cash values (term life insurance cannot be used). You own the policy and your heirs (the designated beneficiaries) receive the proceeds at your death.

Advantages and Disadvantages: By assigning policy dividends to charity, you are able to make a gift without diminishing the amount of your heirs’ inheritance. You retain ownership of the policy allowing you access to the policy’s cash value. The dividends paid to the charity are deductible for both income tax and gift tax purposes. Because you retain ownership of the policy, the proceeds will be included in your gross estate at your death. However, in this case, your estate will not receive an offsetting estate tax charitable deduction because the proceeds will not go to charity. Your estate may be entitled to the unlimited marital deduction, though, if your spouse is the beneficiary. Or, your estate may not owe estate taxes anyway because of the applicable exclusion amount and other deductions and credits. With permanent life insurance policies that are not modified endowment contracts, you do not have to include dividends until they exceed your basis (generally, gross premiums paid) in the policy.

Donate an Existing Life Insurance Policy to Charity

In order to donate an existing life insurance policy to charity, you must assign all rights in the policy to the charity. You must also deliver the policy itself to the charity. The charity becomes the new owner of the policy as well as the beneficiary, but you will continue to pay the premiums (unless the policy is paid up). As the owner, the charity will have access to any cash values during your life. If you retain any “incidents of ownership, ” no income tax or gift tax deductions will be allowed.

Advantages and Disadvantages: The gift of the policy and any future premium payments you make will be deductible for both income tax and gift tax purposes. Further, because you give up ownership of the policy, the proceeds will not be included in your gross estate at your death (unless you die within three years of the transfer, and then your estate will also get an offsetting estate tax charitable deduction). However, by relinquishing ownership of the policy, you give up all control over and rights to the policy, including the ability to change the beneficiary and access to the policy’s cash value. When you donate an existing policy, the amount of your deduction is either the value of the policy or your cost basis (net premiums paid), whichever is less. Premium payments made directly to the insurer may be considered to be gifts for the use of the charity (rather than gifts to the charity) and, as a result, may be deductible only up to 30 percent of your contribution base (your contribution base is generally equal to your adjusted gross income). On the other hand, if you make a cash donation to the charity that is used to pay the premiums, your deduction is limited to 50 percent of your contribution base.

Donate a New Policy to Charity

In order to use this strategy, you purchase a new insurance policy in the charity’s name. You never own the policy. The charity is the owner and beneficiary. You will make any future premium payments (unless it is a single premium policy). As the owner, the charity will have access to any cash values during your life.

Caution: The IRS may treat this transaction as if the charity itself had purchased the policy on your life. Most states require the purchaser of a policy to have an insurable interest in the life of the insured. If the charity does not have an insurable interest, all deductions may be lost. If this is the case in your state, consider having your spouse purchase the policy and then immediately assign all rights to the charity.

If you need help, contact the experts at Henssler Financial: