The use of life insurance in charities has been around for a long time, but it has been out of favor in recent years mainly because many plans did not work as intended. These plans called for the charitable donations (premium payments) to be limited to a specific number of years, for example, a 10-pay plan. Projections were based on dividend assumptions that proved to be optimistic. Some 10-pay plans became more like 15- to 20-pay plans, which was not the original intention.
Now that companies have developed universal life policies guaranteed not to lapse if the required premium is paid (regardless of future interest rates and future insurance charges), charitable organizations are once again considering life insurance as a valuable tool in building their endowments.
My re-entry into charitable life insurance (CLI) started as I was finishing my term on the board of our local foundation. I suggested to the executive director that we embark on a program to increase the amount of life insurance the foundation owned. The foundation’s board approved the program.
I first examined the present policies in force, looked at the present administrative systems and set up guidelines for receiving new life insurance. I then conducted seminars to educate staff members, selected existing foundation donors and worked on marketing the program. We developed a CE credit program to promote the foundation and the use of life insurance in charitable giving.
With direct use, the life insurance is owned directly by the charity.
My approach to CLI is two-fold: direct and indirect use. With direct use, the life insurance is owned directly by the charity. It is recommended that the new life insurance policy be applied for by the charity that will also become the owner and the beneficiary of the policy. The donor makes annual gifts (or it can be a one-time gift) to the charity, and the charity uses the gift to pay the premium directly to the life insurance company. The donor, of course, gets a charitable deduction, and the charity receives the proceeds of the life insurance upon the death of the donor. Potential donors can be of any age, but many charitable organizations prefer older donors for obvious reasons. Life insurance companies have now developed policies that healthy seniors can buy at very reasonable rates. For example, I recently reviewed an illustration for an 85-year-old female in reasonable health that required an annual premium of less than 6 percent of the face amount.
Gifts of existing policies the donor no longer needs should not be overlooked. The ownership of the policy is transferred from the insured to the charity, and the value of the donor’s gift is the lesser of the cash value of the policy (interpolated terminal reserve or replacement cost) or the cost basis of the premiums paid.
With indirect use, life insurance is used to replace an asset a donor is considering gifting to a charity. The donor may hesitate because he doesn’t want to disinherit his heirs. One solution is to use a charitable remainder unit trust (CRUT). Let’s assume that a retired couple, John and Mary Smith, own appreciated stock that is presently producing little income. If they sell the stock, they must pay a substantial amount of tax. For example, $1 million worth of stock with a cost basis of $100,000 could generate taxes of $135,000. A better option might be to consider setting up a CRUT with a 6 percent payout. They would get an immediate income-tax deduction of close to $400,000, and the entire $1 million would be available to provide income to them, as opposed to the $1 million minus the capital gains taxes. Part of the increase in income from the 6 percent pay-out in the CRUT, along with the present income-tax deduction, could be used to purchase a life insurance policy to replace part or all of the $1 million given to the charitable organization in the form of the CRUT. If appropriate, a wealth replacement trust can be created to insure a tax-free transfer to the heirs.
To include CLI in your practice, use a gradual approach that might include charities you can comfortably approach. Also, many of your clients or their parents may have a charitable interest or can acquire one once they see all the benefits of a charitable program. If you are uncomfortable with your knowledge of charitable giving, consider working jointly with an experienced agent.
Daniel W. Hemming, CLU, ChFC, MSFS, a 46-year NAIFA member (Rochester-AIFA), is owner and founder of Hemming Financial Services and a registered representative with Securities America Inc. (Member NASD/SIPC) You may reach him at 585-381-5820.