As you work with clients, keep your ears open for closet philanthropists. Listen to how they spend their time and money. People who volunteer with a charity will often support it financially. In addition, you can look at Schedule A of their tax return or identify their charitable contributions when you discuss their budget.
There are two basic ways you can help clients use permanent life insurance to facilitate charitable giving and obtain potential estate- and income-tax benefits. Remember, if you need help, consult an experienced advisor who can walk you through the technical details.
Charity as beneficiary
The first method involves naming a charitable organization as a primary beneficiary of a life insurance policy. This enables the client to leave all or a portion of a death benefit to the charity. For instance,
Susie is a 75-year-old single woman with a $200,000 whole life insurance policy. She wants to use the cash value to meet potential long-term-care expenditures. However, if Susie does not need the cash value, she would like the Multiple Sclerosis Foundation to receive the death benefit. Thus, she simply names the MS Foundation as her primary beneficiary.
However, if Susie wants the charity to receive the death benefit only if the primary beneficiary dies before she does, then she should name the charity as a contingent beneficiary. For example, suppose Susie meets and marries Don, a swashbuckling 76-year-old widower. Susie wants Don to receive the death benefit if he is alive at her death. However, if Don dies before Susie, she wants the MS Foundation to receive the proceeds. Therefore, she should name Don as the primary beneficiary and the MS Foundation as the contingent beneficiary.
Naming the charity as a beneficiary preserves the client’s control over the life insurance policy, allowing flexibility should her situation change. On the other hand, there is no current income-tax deduction for the policy’s value or for any ongoing premium payments.
Charity as policyowner
A second method entails applying for a new life insurance policy with the charity as the policyowner, or transferring ownership of an existing policy and making annual contributions to the charity equal to the premium (if applicable). There are a few advantages to this approach. For starters, the charity will generally receive a guaranteed amount (the death benefit), albeit at a later date, rather than an annual amount for an uncertain number of years.
Consider Phil, a 50-year-old, who decides to give $4,000 a year to his alma mater for the rest of his life. If Phil dies in 10 years, his school would receive only $40,000. But if Phil were to apply for a $250,000 nonparticipating whole life policy with his school as the policyowner, he could turn that $4,000 annual contribution into a guaranteed $250,000 deferred contribution.
In addition, if the policy has waiver of premium for disability, the premium would be waived for any period of time Phil is disabled. (Note that WPD typically drops off a policy at age 65.) Furthermore, the policy is not includible in his estate (so long as he does not have any incidents of ownership), and he can also potentially deduct the full premium for federal income-tax purposes if he itemizes his return. The deduction amount depends on the type of charity (public or private), the amount of the premium and his adjusted gross income. Phil should make a charitable contribution equal to the amount of the premium rather than pay the premium directly to the insurance company to ensure that he can maximize his deduction.
In the case of transferring ownership of an existing life insurance policy to a charitable organization, the client may be able to deduct the value of the policy as a charitable contribution. If the policy is paid up, the amount of the deduction is the lesser of premiums paid or the replacement cost of the policy. Otherwise, the amount of the deduction is the lesser of premiums paid or the interpolated terminal reserve as determined by a qualified appraiser. (The ITR is approximately equal to the policy’s current cash value.)
There are two drawbacks to the charity’s outright ownership. First, the client has ceded his ownership interests in the policy and cannot change the beneficiary or access the cash value. Second, some states do not deem a charity to have an insurable interest in a donor’s life.
For additional information about planned giving, consider the courses associated with the chartered advisor in philanthropy (CAP) designation that The American College offers.
Kirk Okumura is an LUTC author and editor at The American College. Contact him at Kirk.Okumura@TheAmericanCollege.edu.