Planning Gifts with Life Insurance – part 1

Many years ago when Dr. M. was just a budding young surgeon and father, he decided to purchase a life insurance policy on his life “just in case.” At that time, he had two children and a very large mortgage. Therefore, he sought some financial protection should anything happen to himself, since he was the only income earner and his wife stayed at home to raise their children. Consequently, he purchased a $1,000,000 policy with annual premiums of $10,000.

Now the M’s financial picture is quite different. They have an estate of $4 million, which consists of a $1.25 million home, $2.5 million IRA, and $250,000 of various assets. Both of their daughters’ schooling expenses have been set-aside in education savings accounts. Finally, through the use of credit shelter trusts, bequests, and testamentary charitable remainder trusts, their estate plan was arranged so that no estate tax would be payable at either death. The M’s are very philanthropic and want to make a substantial current gift to their favorite charity.

Question: Since the M’s no longer need the life insurance policy for “just in case” reasons, can they give the paid-up policy to their favorite charity? What are the tax consequences of making such a gift?

Solution: An outright gift of an insurance policy will produce a charitable income tax deduction equal to the lesser of the policy’s value (i.e. interpolated terminal reserve value or replacement cost) or their basis in the policy (i.e. premiums paid). After contacting the M’s insurance company, it was determined that their policy is worth $400,000. The M’s have paid premiums for 25 years. Thus, their basis in the policy is $250,000 (25 x $10,000 annual premium). In many cases, the donor’s premiums paid for the policy will be less than the policy’s value. Thus, the M’s are entitled to a charitable deduction of $250,000. There is no capital gain element involved in the charitable deduction. Therefore, it is treated similar to a cash-type of gift.

The M’s love the tax and charitable benefits of the plan. As a result, they transfer all ownership and rights in their policy to the charity. Contacting the insurance company and completing the proper change of ownership forms provided by the insurer accomplished this. Once the charity is the owner of the policy, charity may hold or surrender the policy. In this instance, after discussions with the M’s, it was determined that charity would use the policy’s death benefit proceeds to establish a major endowment bearing the M family name, with the fund income to be used each year for the charity’s general operations.

Dr. M’s “just in case” plan provided peace of mind, excellent tax savings and a substantial gift to his favorite charity.

Jackie Jacobs is the Executive Director of the Columbus Jewish Foundation, the Central Ohio Jewish community’s planned giving and endowment headquarters.

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