LEGACY ALLIANCE AND THE ROLE OF LIFE INSURANCE
By Ed Sheldon
Summer 2006, NEWS
The practice of giving life insurance to charity is well established. Over the past decade, increasing numbers of individuals and businesses have recognized the value of life insurance in connection with philanthropic estate planning. There are two basic approaches which feature the use of life insurance in this regard:
- Outright gifts of life insurance to charities, and
- The use of life insurance to replace the value of other assets which are gifted or bequeathed to charity thereby continuing to remember your human heirs.
OUTRIGHT GIFTS OF LIFE INSURANCE
While gifts of almost any type of property result in warm feelings and tax advantages for the donor, gifts of life insurance enjoy some particular advantages:
- A much larger potential gift can be made with life insurance than through the gift of any other asset. A charitable pledge equal to the face amount of a life insurance policy can be fulfilled either through a single gift which represents a fraction of the total pledge or on the “installment plan” through annual premium payments. Depending upon the age and health status of the donor and the timing of the donor’s demise, the benefits received by the charity may be many times the amount of the contributions made into the policy.
- If the donor makes a gift of appreciated real or personal property or stock, the charity can sell the property or
stock and use the proceeds to pay life insurance premiums. The donor avoids capital gains tax on the appreciation
and receives an income tax deduction based on the full fair market value of the property while the heirs receive the proceeds
of the insurance upon the death of the insured. The donor wins, the heirs win, our Westies win. Only the government loses.
- If the charity is made the owner of the policy, the charity has the use of the policy’s cash value during
the donor’s lifetime. Dividends may be used and policy loans taken to meet current cash needs.
- Life insurance is not subject to the delays and expenses of the probate process. The charity, or the heirs, may
expect to receive the proceeds within thirty days of the insured’s death under normal circumstances.
- The program is self-completing, in the sense that the charitable pledge can be fulfilled whether the donor
lives for many years or dies in the early stages of the program. No other asset can guarantee the same result
without a contribution of the full amount of the pledge at the outset.
- The program is simple to implement. No legal agreements are required and there are no extra administrative
costs associated with the arrangement.
METHODS OF GIFTING
A donor can choose among a variety of strategies for making a charitable gift of life insurance. The most common
approaches are the following:
- The donor can retain ownership of the policy and simply name the charity as revocable beneficiary of the policy.
Although this approach creates no income tax advantage for the donor, it does permit the donor to invade the policy values in
an emergency or change the beneficiary until the moment of death. Although the policy proceeds are includible in the donor’s estate
using this approach, the estate receives an offsetting charitable estate tax deduction that eliminates any tax on the proceeds.
- The more common approach is to name the charity as owner of the policy. This is true whether the policy is newly issued or is
an existing policy that the donor has determined is no longer needed for family purposes. If an existing policy is gifted to the charity,
the donor will be entitled to a current income tax deduction equal to the lesser of (a) the fair market value of the policy or (b) the donor’s
cost basis in the policy. With this approach, the proceeds are not included in the donor’s estate, or are offset by the estate tax charitable
deduction.
ASSET REPLACEMENT
Because of the heavy taxes imposed on QUALIFIED RETIREMENT PLAN BENEFITS and IRA’s -- wherein a $1 million accumulation left
to someone other than a spouse or a charity could shrink to about $270,000 in the hands of the ultimate beneficiary -- life
insurance policies are ideal vehicles for charitable gifts. When such assets are left to a CHARITABLE REMAINDER
TRUST (CRT), a portion of the estate tax that would otherwise be due is saved and the income taxes are deferred.
Assume that the donor in such a case had wanted his beneficiaries to enjoy a lump sum inheritance at the time of
his death closer to the real value of $1 million. The donor could have used lifetime distributions from the IRA or qualified plan,
or other assets, to purchase life insurance outside of his estate. At his death, his heirs would receive the life insurance
proceeds free of income and estate tax while the balance of the retirement accumulation passes to the CRT. (The amount
of life insurance depends upon the age and health status of the insured, as well as the policy design.) The donor’s heirs enjoy
income from the CRT with the principal ultimately passing to the charity.
Alternatively, the donor might have decided that it was important for the charity to receive its gift at the time of his
death. In that case, he could plan to leave the retirement accumulation outright to the charity at his death with an
appropriate amount of life insurance proceeds passing to his heirs to replace the value of the charitable gift. Life
insurance is commonly used as well to replace the value of assets gifted to charitable trusts during the lifetime of the donor.
SUMMARY
Any person of philanthropic bent who wishes to multiply the positive results that flow from giving should consider a
gift of life insurance to charity. Life insurance can also be an extremely valuable tool for those who want to be certain
that their charitable gifts will not be made at the expense of their families. Please be aware that the laws
pertaining to wills and estates differ from State to State. Before finalizing your gift, consult a licensed attorney experienced
in the laws pertaining to estate planning.
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