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 fully paid for (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.
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.
When making an irrevocable gift of a policy to a nonprofit, the primary benefit to the donor 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. However, 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 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.
To begin the process, the Step 1 is to decide how much you would like to give to a favorite cause on an annual basis. Step 2; consult with a qualified life insurance agent to determine what kind of death benefit such a gift – as a premium payment to a life insurance policy – might cost to purchase. Step 3; contact a representative of your favorite cause who directs the endowment programs for that cause, and discuss this proposed strategy. Carefully consider all aspects of gifting money in this manner. Step 4 involves filling out an application for a permanent life insurance policy on your life, naming you as the insured, and the charity or favorite cause as the owner and beneficiary of the policy. It is not necessary to set up a trust fund with its associated expenses, unless you want to do so. Step 5; upon successfully completing the underwriting process, have the insurance agent set up a meeting with you and the charity’s representative to go over the issued policy and, if the policy is acceptable to all parties, make a donation to the charity in the amount of the policy’s premium payment. With Step 6 you should obtain a complete photocopy of the insurance policy for your records. Step 7; obtain a receipt for your donation documenting your tax-deductible payment to a charitable cause for that tax year. Step 8 is to continue to make donations for as long as premiums are necessary to keep the policy in force, taking a tax deduction each year for the donation (as far as is allowable under the tax code current at that time). Step 9 is when you die, the charity or cause will receive an income-tax-free payment by virtue of the policy’s death benefit, which is likely to be many times greater than the sum of all of your donations for premium payments.
Gifts of life insurance do not require constant attention as other types of investments may require. There are a variety of ways to set-up a charitable gift using life insurance:
- You may give a gift that becomes self-completing. Life insurance can provide for a self-completing gift in the event of your death or disability.
- You may give a bequest at death. The proceeds of the policy will be paid to their charity free of any federal estate tax. This will be true whether you own the policy or the charity owns the policy.
- You may continue to own your policies, and name your favorite organizations as beneficiaries. If you are concerned that your family’s circumstances may change in the future, you may name the charity as “revocable” or “contingent” beneficiary and still retain flexibility and control. The policy’s proceeds will be passed free of both gift and estate taxes.
- You may give an existing policy. You may have several insurance policies, each purchased at different times in your life to satisfy a specific need at that time. Some of those needs may no longer exist (e.g., home mortgage or children’s education). Your gift of that policy to charity allows you to take an income tax deduction for the amount of the policy’s fair market value (approximately the policy’s cash value) in the year you transfer the policy. Any future premiums paid are also income tax deductible.
- Your may give policy dividends. Life insurance policy dividends received in cash can be donated to charity. This is an easy, economical way to make charitable gifts and generate income tax savings.
Charitable giving using life insurance is both beneficial and a favored means of making charitable contributions for a number of reasons:
- The death benefit going to your favorite charity is guaranteed as long as premiums are paid. This means that the charity will receive an amount which is fixed in value.
- Life insurance provides an amplified gift that can be purchased on the installment plan. Through a relatively small annual cost (premium), a large benefit can be provided for your charity. A large gift can be made without impairing or diluting the control of your family business interest or other investments. Assets earmarked for your family can thus be kept intact.
- Life insurance is a self-completing gift. If you become disabled, the policy can remain in full force through the waiver of premium rider. Even if death occurs after only one premium payment, the charity is assured of its full gift. Additionally, the death proceeds can be received by your designated charity free of federal income and estate taxes, probate and administrative costs and delays, brokerage fees or other transfer costs.
- Because of the contractual nature of a life insurance contract, a large gift to charity is not subject to attack by disgruntled heirs. Life insurance proceeds do not run afoul of the so-called mortmain statutes that prohibit or limit gifts made within a short time prior to death.
- A substantial gift may be made with no attending publicity. Since the life insurance proceeds paid to charity can be arranged so that they will not be part of your probate estate, the proceeds can be paid confidentially. Of course, publicity may be given if desired.
If you have ever wondered how you might “give something back,” or felt drawn to support a particular charity, one of the most affordable and beneficial ways, is through the use of life insurance.