Charitable Giving Planning:
Charitable Gifts of Life Insurance
Life insurance has a number of beneficial uses and is a critical component of personal, business, and estate financial planning. It is often used to replace earnings in the event of premature death, fund business succession plans, and provide liquidity for the payment of estate taxes. What is sometimes overlooked is that life insurance can also serve an important role in charitable planning. This article will examine two ways in which a life insurance policy can be used to fund a significant charitable gift by naming a charity as a beneficiary of a policy, or by transferring ownership of an existing policy to a charity.
Naming a Charity as Beneficiary of a Policy
Many philanthropic-minded individuals lack the resources to make major charitable gifts. However, by naming a charity as beneficiary of a life insurance policy, an individual can leave a signifi cant charitable legacy without losing control of the policy and its cash value during his or her lifetime. The insured will remain as the policy owner during his or her life and reserves the right to change the beneficiary designation and maintain access to the policy cash value. Although the insurance proceeds will be included in the taxable estate of the insured, the insured’s estate should receive an offsetting estate tax charitable deduction of an equal amount.
Transferring Ownership of an Existing Policy to Charity
During an individual’s “wealth accumulation years,” it is common for an individual to purchase life insurance to protect his or her family against premature death. As the insured ages and his or her children reach adulthood, the need for life insurance for income replacement becomes less important. In many cases, the policy is owned by the insured and the proceeds will be subject to estate tax at the insured’s death. In these instances, giving an existing life insurance policy to charity will allow the insured to:
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keep the proceeds out of his or her taxable estate without gift tax liability
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receive a current income tax charitable deduction
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provide a substantial benefit to a charity of the insured’s choice
By giving up all control of the policy during life, the insured will receive a current income tax deduction. The insured should complete an absolute assignment to effectuate the transfer of the policy. If additional gifts to the charity are made after the policy is transferred to charity (so that the charity can pay premiums), the insured will also receive income tax deductions for these gifts. An insured can fund a substantial life insurance policy with a small annual charitable contribution. Because the charity owns and controls the policy, the insurance proceeds will not be included in the estate of the insured. (Note: While the proceeds will be drawn back into the estate if the insured dies within three years of transferring the policy, the estate should receive an offsetting charitable deduction). In addition, the charity should recognize the insured as having made a lifetime gift.
Once the insurance contract is given to charity, the insured can no longer change the beneficiary designation or access the policy’s cash value. If the charity has an immediate need for liquidity, the charity can access the policy’s cash value – jeopardizing the insured’s plans to leave a signifi cant legacy at death.
Important Considerations for Giving a Life Insurance Policy to Charity
Qualification for Charitable Deduction
Before making contributions to a “tax-exempt” organization, an individual should determine whether such contributions will qualify for the applicable income tax, gift tax, and estate tax charitable deductions. Contributions made to some types of “tax-exempt” organizations do not qualify for the income tax, gift tax, or estate tax charitable deductions, or the amount of the deduction may vary. Applicable charitable deduction rules should always be considered.
Life Insurance Policy Valuation
It is important that an existing life insurance policy which is contributed to charity be properly valued for purposes of the charitable income tax deduction. There are some variations on how certain types of policies should be valued. An existing policy with loans outstanding is not recommended for a gift to charity since the transfer of the policy will be treated as a part sale/part gift transaction.
Deduction Limitations
Lifetime contributions to qualified charities do not create unlimited income tax charitable deductions. Income tax charitable deductions are limited by a percentage of “adjusted gross income” or “AGI.” Generally, cash contributions and contributions of ordinary income property (which would not be subject to capital gains upon sale) to public charities are subject to a 50% AGI limitation, whereas appreciated capital gains property, such as real estate or stock, is subject to a 30% AGI limitation. (See IRC Sec. 170. Gifts of real estate and stock are generally valued at their fair market value as of the date of the gift for charitable deduction purposes.) Gifts of cash and ordinary income property to private foundations are ordinarily subject to a 30% AGI limitation, whereas property other than cash is usually subject to a 20% AGI limitation. Because life insurance is an ordinary income asset, it should be subject to the 50% AGI limit for contributions to public charities and the 30% AGI limit for contributions to private charities. Unused income tax charitable deductions may be carried forward for five years on future income tax returns.
Substantiation
No income tax charitable deduction is allowed for a charitable contribution unless the taxpayer has written substantiation of the contribution from the charitable organization. Deductions in excess of $5,000 require a “qualified appraisal.” The donor, not the charity, has the responsibility to get the property appraised. The Pension Protection Act of 2006 (PPA), has instituted new requirements for substantiation of gifts and qualified appraisers.