The Benefits Of Life Insurance For Charitable Planning
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There are many benefits to making gifts to a favorite charity. Primarily, the individual making the gift receives great satisfaction out of helping an important cause. Secondly, there can be significant tax benefits associated with making charitable gifts.
A current income tax deduction may be available to the donor for certain gifts, subject to various rules and limitations. It is also possible for the donor to avoid capital gains taxation on certain gifts of securities. An estate tax charitable deduction may also be available for testamentary bequests.
Furthermore, life insurance can be an effective and efficient tool for an individual to use to make or replace a significant gift while receiving the tax benefits associated with charitable giving.
Donating An Existing Policy
Often, individuals own life insurance to satisfy various needs. However, over time those needs change, and the life insurance may no longer be necessary. A gift of an existing life insurance policy may be made to a charity, especially if the donor wants to make a significant or specified gift, but cannot afford to contribute the entire amount from his current assets.
An individual can transfer ownership of an existing life insurance policy, giving up all rights to it, and receive an income tax deduction for the gift. The value of the permissible deduction is the cost basis in the policy or the fair market value of the policy if it is lower. The fair market value of the policy is the interpolated terminal reserve as of the transfer date. However, no deduction is allowed if there is a loan on the policy that is transferred.
For example, Robert and Natasia Jones, a married couple, ages 71 and 69 respectively, decide to make a gift of their existing $1,000,000 survivorship universal life policy to a specified charity. The cumulative premiums paid to date are $75,000 and the fair market value or cash value is $72,000. If they are in a 40% tax bracket, they can take a current income tax deduction of $75,000 yielding them a tax savings of $30,000 in the year of transfer, subject to AGI limitations.
The charity would then be required to pay ongoing premiums, if any, in order to keep the policy in place until death. The charity would receive the $1,000,000 at the death of the second insured to die.
Ideally a guaranteed, limited pay policy is the best type to transfer so that the charity does not have to continue paying premiums.
Purchasing A New Policy For Charity
Alternatively, a donor can purchase a new life insurance policy on his life and pay the premiums on the policy and name the charity as a beneficiary. However, no current income tax deduction is allowed in this case since the insured still has full ownership rights in the policy, primarily the right to change the beneficiary designation. Although the policy will be included in the estate of the owner at death for estate tax purposes, the estate will receive an estate tax charitable deduction for the full value transferred to the charity.
Robert and Natasia, from our previous example, could purchase the $1,000,000 survivorship universal life policy today and pay annual premiums of $17,005. The charity would be named the beneficiary. Assuming a joint life expectancy of 18 years, the total non-deductible premium payments are $289,085, which equates to an out-of-pocket net present value at 5% of $191,715. The net present value at 5% of the $1,000,000 death benefit is $436,297.
Since Robert and Natasia own the policy outright, the policy proceeds of $1,000,000 will be included in their estate for estate tax purposes. However, their estate will get a corresponding estate tax charitable deduction to offset any estate taxes incurred.
Making Premium Contributions To Charity
A donor can also make income tax deductible cash contributions to a charity, and the charity may then direct those contributions to purchase a new life insurance policy on the life of the donor.
In this case, Robert and Natasia could make deductible cash contributions of $17,005 annually to the charity. At a 40% tax bracket, the annual savings from the deduction is $6,800, resulting in a net annual cash outlay of $10,203–or, $173,451 over 18 years. The net present value of the net cumulative premiums at 5% is $115,029, and the net present value of the $1,000,000 death benefit going to the charity in year 18 is $436,297.
Use A Charitable Remainder Trust (CRT)
Finally, an individual can make a gift to a Charitable Remainder Trust (CRT) for the benefit of a charity. A CRT is an irrevocable trust established by one or more donors, for the benefit of a charity. A CRT provides a stream of income to a named income beneficiary or beneficiaries (chosen by the donor), as well as income and estate tax benefits to the donor(s).
The CRT can be established during lifetime or at death. The donor can choose to be the trustee and the trustee can change the charitable beneficiary of the CRT at any time. However, there are deduction limitations and specific guidelines for CRTs (see sidebar).
Typically, a donor transfers highly appreciated assets to the CRT. However, securities with low appreciation, real estate, personal property and cash can all be transferred as well. By transferring highly appreciated assets the donor avoids capital gains tax on the sale of the assets. The trust, as a tax-exempt entity, upon receipt of the asset, typically sells it and creates a diversified portfolio from which the trustee of the trust can make income payments to the designated income beneficiary of the trust. The income beneficiary pays income taxes on the income, which is typically paid out quarterly.
Alternatively, they could transfer the $1,000,000 of stock to a charitable remainder unitrust (CRUT) so that they can begin receiving income immediately, as they are retired, for the rest of their joint lives. The trust would be for the benefit of a public charity. The annual income they receive will be based on the annual value of the trust assets.
