The Benefits Of Life Insurance For Charitable Planning

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There are many benefits to making gifts to a favorite charity. Primarily, the individual making the gift receives great satisfaction out of helping an important cause. Secondly, there can be significant tax benefits associated with making charitable gifts.

A current income tax deduction may be available to the donor for certain gifts, subject to various rules and limitations. It is also possible for the donor to avoid capital gains taxation on certain gifts of securities. An estate tax charitable deduction may also be available for testamentary bequests.

Furthermore, life insurance can be an effective and efficient tool for an individual to use to make or replace a significant gift while receiving the tax benefits associated with charitable giving.

Donating An Existing Policy

Often, individuals own life insurance to satisfy various needs. However, over time those needs change, and the life insurance may no longer be necessary. A gift of an existing life insurance policy may be made to a charity, especially if the donor wants to make a significant or specified gift, but cannot afford to contribute the entire amount from his current assets.

An individual can transfer ownership of an existing life insurance policy, giving up all rights to it, and receive an income tax deduction for the gift. The value of the permissible deduction is the cost basis in the policy or the fair market value of the policy if it is lower. The fair market value of the policy is the interpolated terminal reserve as of the transfer date. However, no deduction is allowed if there is a loan on the policy that is transferred.

For example, Robert and Natasia Jones, a married couple, ages 71 and 69 respectively, decide to make a gift of their existing $1,000,000 survivorship universal life policy to a specified charity. The cumulative premiums paid to date are $75,000 and the fair market value or cash value is $72,000. If they are in a 40% tax bracket, they can take a current income tax deduction of $75,000 yielding them a tax savings of $30,000 in the year of transfer, subject to AGI limitations.

The charity would then be required to pay ongoing premiums, if any, in order to keep the policy in place until death. The charity would receive the $1,000,000 at the death of the second insured to die.

Ideally a guaranteed, limited pay policy is the best type to transfer so that the charity does not have to continue paying premiums.

Purchasing A New Policy For Charity

Alternatively, a donor can purchase a new life insurance policy on his life and pay the premiums on the policy and name the charity as a beneficiary. However, no current income tax deduction is allowed in this case since the insured still has full ownership rights in the policy, primarily the right to change the beneficiary designation. Although the policy will be included in the estate of the owner at death for estate tax purposes, the estate will receive an estate tax charitable deduction for the full value transferred to the charity.

Robert and Natasia, from our previous example, could purchase the $1,000,000 survivorship universal life policy today and pay annual premiums of $17,005. The charity would be named the beneficiary. Assuming a joint life expectancy of 18 years, the total non-deductible premium payments are $289,085, which equates to an out-of-pocket net present value at 5% of $191,715. The net present value at 5% of the $1,000,000 death benefit is $436,297.

Since Robert and Natasia own the policy outright, the policy proceeds of $1,000,000 will be included in their estate for estate tax purposes. However, their estate will get a corresponding estate tax charitable deduction to offset any estate taxes incurred.

Making Premium Contributions To Charity

A donor can also make income tax deductible cash contributions to a charity, and the charity may then direct those contributions to purchase a new life insurance policy on the life of the donor.

In this case, Robert and Natasia could make deductible cash contributions of $17,005 annually to the charity. At a 40% tax bracket, the annual savings from the deduction is $6,800, resulting in a net annual cash outlay of $10,203–or, $173,451 over 18 years. The net present value of the net cumulative premiums at 5% is $115,029, and the net present value of the $1,000,000 death benefit going to the charity in year 18 is $436,297.

Use A Charitable Remainder Trust (CRT)

Finally, an individual can make a gift to a Charitable Remainder Trust (CRT) for the benefit of a charity. A CRT is an irrevocable trust established by one or more donors, for the benefit of a charity. A CRT provides a stream of income to a named income beneficiary or beneficiaries (chosen by the donor), as well as income and estate tax benefits to the donor(s).

The CRT can be established during lifetime or at death. The donor can choose to be the trustee and the trustee can change the charitable beneficiary of the CRT at any time. However, there are deduction limitations and specific guidelines for CRTs (see sidebar).

Typically, a donor transfers highly appreciated assets to the CRT. However, securities with low appreciation, real estate, personal property and cash can all be transferred as well. By transferring highly appreciated assets the donor avoids capital gains tax on the sale of the assets. The trust, as a tax-exempt entity, upon receipt of the asset, typically sells it and creates a diversified portfolio from which the trustee of the trust can make income payments to the designated income beneficiary of the trust. The income beneficiary pays income taxes on the income, which is typically paid out quarterly.

The donor and/or one or more individuals are named as income beneficiaries of the CRT and receive an income stream (retained interest) from the trust for life, or a specified period of time not to exceed 20 years. The income stream is based on the payout rate established at the creation of the trust.

The calculation of the payout rate will take into account three tests, as outlined in chart 1, in an attempt to protect the charitys remainder interest. If these tests are not passed, the trust will not qualify as a CRT and the donor will not be able to receive the tax benefits associated with gifts made to it.

The donor receives a current income tax deduction for the present value of the trust balance remaining (remainder interest) for the charity after the income has been paid out (retained interest). The present value of the remainder interest, calculated when the trust is funded with the gift, is based on the monthly 7520 rate. This is the rate the government uses as a benchmark rate of return when projecting the remainder value of a charitable gift after income payments are made.

The ages of the income beneficiaries and the time period for which income is to be received, the amount of the gift, and the payout rate at the date of transfer are all part of the deduction calculation. Providing the CRT is a valid one, the deduction is not revised based on actual investment results.

The Wealth Replacement Trust

Many times a donor would like to leave a substantial gift to charity but wants to be fair to family members. In this case, an irrevocable wealth replacement trust (WRT) designed to hold life insurance can replace the gift transferred to the charity.

The least expensive way of replacing the charitable gift is to have the trust purchase life insurance on the life of the donor. The cost of replacing the gift is the premium on the policy and not the value of the entire gift. The replacement value of the policy is typically the value of the asset on the transfer date. However, in some instances the amount of insurance purchased may take into account an adjustment for what the asset would be worth at death.

For example, assume that Robert and Natasia own highly appreciated stock with a market value of $1,000,000 and a cost basis of $100,000. They are thinking of liquidating the stock in order to reinvest it for retirement income purposes. If they sell the stock, they would pay $180,000 in capital gains taxes before they could reinvest the money for income.

Alternatively, they could transfer the $1,000,000 of stock to a charitable remainder unitrust (CRUT) so that they can begin receiving income immediately, as they are retired, for the rest of their joint lives. The trust would be for the benefit of a public charity. The annual income they receive will be based on the annual value of the trust assets.

The maximum annual payout rate established at the creation of the trust is 14.8%, passing all the necessary tests referred to in chart 1. In order to calculate the income tax deduction they use the current 7520 rate of 4.2%.

The first-year net CRT income amount Robert and Natasia would receive based on the 14.8% payout rate and a 40% income tax bracket is $108,459. However, if the savings associated with the tax deduction of $40,000 is taken into account, the first-year total income payment to Robert and Natasia is $148,459. This assumes a $100,000 permissible deduction with no carry-over necessary given their current AGI.

Robert and Natasia like the idea of the CRT but are concerned that their children will not benefit from the stock at their death. They decide to go one step further and establish a wealth replacement trust that can purchase insurance on their joint lives so that at their death their children will receive $1,000,000. The premium is $17,005 per year and will be paid as an annual exclusion gift to the trust by Robert and Natasia, and will avoid gift taxes. The cash to pay the premiums will come from the CRT income. Hence, the first-year net income after taxes and insurance premiums available to Robert and Natasia as spendable income is $131,454.

Therefore, they will be able to make a $1,000,000 gift to a charity of their choice, a gift of $1,000,000 to their children without any gift tax consequences, and reap the benefits of a sizable income stream for the rest of their lives from the very assets they gave away.

In addition, they are able to avoid the capital gain tax on the asset they transferred to the trust, as well as benefit from the savings from the charitable income tax deduction.

See Chart 3 for a comparison of the income, tax deduction and benefit to charity of selling the asset and not making a charitable gift, creating a charitable remainder unitrust (CRUT), and creating a CRUT with a wealth replacement trust (WRT) funded with insurance.

Flexibility Of Charitable Remainder Trusts

The Charitable Remainder Trust can provide a charity with a significant gift while providing the donor with a great deal of flexibility. For instance, a CRT can be structured as a standard annuity trust or as a unitrust, both of which pay out income annually. Or, for example, a CRT can be set up to delay income payments until a specified time period, such as retirement.

Furthermore, contributions to a CRT can be leveraged using life insurance. CRTs can be structured to allow for the purchase of life insurance, with ongoing deductible contributions coinciding with premium payments, and providing rolling income tax deductions. The tax savings from the deductions can be used to pay for an additional life insurance policy held by a wealth replacement trust, to replace the asset for the benefit of the donors family.

There are many ways to make gifts to a favorite charity using life insurance. Along with the satisfaction of making the gift come favorable income and estate tax savings. Existing life insurance policies can be transferred to a charity, premium gifts can be made to the charity annually, a charity can be named as beneficiary on an existing or new life insurance policy, or a gift can be made to a charitable remainder trust for the benefit of a charity, while a wealth replacement trust funded with life insurance can be established for the benefit of the donors family.

Lina Storm, CLU, ChFC, is an advanced marketing consultant with Manulife Financial in Boston. She can be reached at via e-mail at lstorm@manulifeusa.com.


Reproduced from National Underwriter Life & Health/Financial Services Edition, December 2, 2002. Copyright 2002 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.