Using ‘ChOLI’ To Spice Up A Planned Giving Program

By James R. Allen

There are many charitable giving techniques that can be incorporated into a financial or estate plan to help your clients meet their financial objectives, while at the same time satisfying their charitable aspirations.

Financial planning objectives aside, charitable giving is also commonly done merely for altruistic purposes without any thought of tax benefits.

Charitable gifts can take many forms, from something as simple as the weekly church offering, to the very complex charitable lead trusts and charitable remainder trusts. For those charities with donors who make regular ongoing charitable donations of cash or property, one possible method of leveraging these charitable gifts is for the charity to use these gifts to purchase charity owned life insurance or “ChOLI” on the lives of its donors.

Using ChOLI creates an opportunity for a charity to substantially increase its overall endowment if it is willing to defer some current benefit in exchange for larger future benefits. The ChOLI program is also beneficial to donors since for a relatively small cost (the life insurance premium), the donor can make a large gift to charity (the death benefit).

ChOLI programs can be an effective strategy for use by the largest charities all the way to small family controlled private foundations.

Designing a ChOLI Program

In the typical ChOLI program, the charity decides to purchase life insurance policies on a group of key donors. The donors agree to make charitable donations of cash so that the charity can pay the insurance premiums. The charity applies for the life insurance and is named the owner, beneficiary, and premium payer of the policy.

For large charities, it may be cost effective to purchase insurance on a substantial number of donors with an expectation that some donors will die each year and the charity will receive a continuous stream of death benefits. This “aggregate funding method” is not unlike those programs used in large executive deferred compensation plans.

It may also be possible for charities to borrow the funds to purchase the life insurance with the donors gifting just the annual interest cost rather than the entire premium. There are certain insurance carriers who market financed insurance programs where lenders will loan funds to purchase life insurance at very favorable interest rates and where the loan can be paid off only at death.

One possible caveat with this leveraged approach is that the charity could run afoul of the “debt financed income” rules and create taxable income for the charity. The possibility of a debt financed income problem should be considered prior to using a leveraged ChOLI program.

It should also be noted that, in a handful of states, charities are not given an insurable interest in their donors and this may preclude the use of ChOLI in those states. Fortunately, the vast majority of states do provide an insurable interest for charities purchasing life insurance on their donors.

In addition to the purchase of new life insurance policies on donors, another approach for charities looking to establish a ChOLI program would be to solicit donor contributions of existing policies.

Often, individuals may have purchased life insurance policies many years ago and no longer have a need for the coverage. By contributing existing unwanted policies to charity, donors could make a significant gift without affecting their current cash flow.

Donors Tax Treatment of ChOLI

Assuming the charity is a public charity, the insured donor would be entitled to deduct the cash donation for the premium, up to 50% of adjusted gross income. If the contribution cannot be fully deducted in the current year, the unused deduction can be carried forward an additional five years.

The ChOLI technique can also work well with a clients private foundation. In cases where the clients private foundation is the charitable recipient, the deduction is reduced to 30% of adjusted gross income with a five-year carry forward.

Also, in situations where the donor pays the premium directly to the insurance company, this may be treated as a contribution “for the use of charity” rather than a contribution “to charity.” This would reduce the deduction limit from 50% to 30% of AGI (assuming a public charity).

Consequently, for donors who are already making large charitable gifts and want to fully utilize the charitable deduction limits, it is better to gift cash to the charity and then have the charity pay the premium to the insurer.

When an existing policy is gifted to a charity, the value of the gift for deduction purposes is the replacement cost of the policy. The replacement cost of the policy can be provided by the insurance company and in most cases will be the policys interpolated terminal reserve.

Unfortunately for the donor, a charitable donation of an existing life policy is subject to an additional limit in deduction value because the policy is “ordinary income property.” With ordinary income property, the income tax deduction is limited to the lesser of the policy’s fair market value or the donors cost basis in the property.

For example, if a donor contributes a policy with a cash value, or replacement cost, of $1,000 and has paid $500 in premiums (cost basis), the deduction value will be the $500 cost basis, not the surrender value.

One additional area of caution for both charities and donors is to avoid application of the “charitable split dollar” rules. In response to some perceived abuses in the marketing of charitable split dollar, or charitable reverse split dollar plans, Congress enacted IRC 170(f)(10) which disallows a donors charitable deduction if the donor or anyone else other than the charity is directly or indirectly a beneficiary of the policy.

Any charity that participates in an arrangement described in 170(f)(10) is subject to a 100% excise tax on the premiums paid, plus the possibility of losing tax-exempt status. By establishing a ChOLI program where the charity is the sole owner and beneficiary of the policy, the significant negative implications of the charitable split dollar rules can be avoided.

Charitable giving can be a rewarding and effective part of any financial plan. Adding a ChOLI strategy to a charitys planned giving program can dramatically leverage the ultimate value of gifts made by the charitys donors.

For the donor, a small cash gift of life insurance premiums (or possibly an existing life insurance policy), can be turned into a significant endowment when the donor dies. Adding ChOLI to the planned giving program can be a win-win for both the charity and its donors.

James R. Allen, CFP, CLU, ChFC, MSFS, is assistant vice president, advanced markets for MetLife Investors in Newport Beach, Calif. He is a co-author of the National Underwriter publication: The Tools & Techniques of Charitable Giving. He can be reached at jim.allen@

investmet.com


Reproduced from National Underwriter Life & Health/Financial Services Edition, December 3, 2001. Copyright 2001 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.


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