Planning Gifts with Life Insurance – part 2
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 life insurance 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 gift upon their death to their favorite charity.
Question: Since the M’s no longer need the life insurance policy for estate tax or “just in case” reasons, can they transfer their existing life insurance policy to charity? Who will pay the remaining premiums on the policy each year? What are the tax consequences of making such a gift?
Solution: Under state law, a donor may transfer an existing life insurance policy to charity. Generally, the transfer is completed by the donor irrevocably designating charity as the beneficiary of the policy and assigning all the incidents of ownership in the policy to charity. 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 $300,000. The M’s have paid premiums for 20 years. Thus, their basis in the policy is $200,000 (20 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 $200,000. It is treated similar to a cash-type of gift.
With respect to the remaining annual premiums, the donor will typically continue to make those payments. Specifically, the donor will make cash contributions of $10,000 to charity each year, so that charity may maintain the policy. It is important, however, to note that charity is not obligated to pay the premiums.
Charity owns the policy outright and may elect to surrender the policy at any time. However, in nearly all cases, charity will honor the donor’s wish to keep the policy intact. Therefore, as long as the M’s continue to contribute $10,000 each year, the charity will pay the life insurance premiums. As a result of this plan, the M’s will be entitled to additional charitable income tax deductions each year they contribute $10,000 to charity. The M’s would like the charity to use the policy’s death benefits to establish a major endowment bearing the family name, with the fund income to be used each year for the charity’s general operations.
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 their favorite charity. Contacting the insurance company and filling out the proper change of ownership forms provided by the insurer accomplished this. In the end, 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.