Planning Gifts with Life Insurance – part 3

Part 3 of 3
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. 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, both 75, are very philanthropic and want to make a substantial gift to their favorite charity upon their deaths. However, they also would like additional income for their lifetimes because “you never know.”

Question: Can the M’s transfer their insurance policy in exchange for a lifetime income plan such as a charitable gift annuity? What are the benefits and tax consequences of making such an exchange?

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.

If the M’s transfer their insurance policy in exchange for a $400,000 two-life gift annuity, their charitable deduction would be approximately $85,000 (not the 30% limitation). There is no capital gain element involved in the charitable deduction, and the contribution is treated similar to a cash-type of gift. Based upon the joint ages of 75 and a 5% annuity payout, the M’s gift annuity also would provide approximately $352,000 of income during their lifetimes. Finally, the M’s favorite charity would receive about $135,800 when the gift annuity ends. This will be used to establish a permanent endowment fund bearing the M family name, with the fund income to be used 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 in exchange for a gift annuity. Contacting the insurance company and filling out the proper change of ownership forms provided by the insurer accomplished this. Once the charity is the owner of the policy, the charity may hold or surrender the policy. In this instance, for liquidity and diversification purposes, the charity elected to surrender the $400,000 policy and reinvest the funds. In the end, Dr. M’s “just in case” plan provided additional income, excellent tax savings and a substantial gift to his favorite charity. In other words, the gift annuity solution met all of the M’s financial and charitable goals!

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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