In light of the financial meltdown, it is a good time to talk to the (still) wealthy about using life insurance as a financial tool for giving to charity.
For those with a private foundation, help them think about using life insurance as “asset replenishment” after the recent market storm. The idea is simple: to replenish asset losses of the foundation using life insurance on the donor’s life, thereby creating dollars not there today for real leverage tomorrow.
Life insurance potentially avails donors of new opportunities to make gifts. Today, most donors are simply thinking of how to complete gifts already made and are making few new commitments. You can help them ensure that assets that have been lost are recovered or guarantee a nice return.
Charities love planned gifts. And today they are looking for good planned giving stories to tell. Help them by exciting your clients about the power of giving life insurance. After many exotic and hyped investments failed or proved fraudulent, demonstrating the tax-free growth and returns of life insurance, a known commodity, is cool again.
Life insurance lets donors have a real impact on, for example, their alma mater. The school would apply for, say, a $1 million life insurance policy of which the school would be both owner and beneficiary. The donor would make annual gifts of the premium to the school and take charitable deductions for doing so.
In a recent example of this strategy, my firm helped a 55-year-old man create a gift using life insurance because making a current cash gift was not an option. We suggested he determine his insurability in a preliminary underwriting test. After collecting medical records, the underwriter at our chosen carrier deemed him to be in “preferred” health. Result: He could accomplish his goal of a $1 million policy with his budget.
After full underwriting, it turned out he was “super preferred”–all the better. This created a roughly $9,500 annual premium for the policy. He examined several funding alternatives, including “pay forever” and abbreviated scenarios, and determined the pay forever was the best bet because it provided the best return on his investment.
He also wanted the policy to last until age 100 with cash value in the contract, but he did not want to fund the policy to have it endow (wherein the cash value equals the death benefit at age 100). The internal rate of return (IRR) of the contract if the donor lives to be 100 will be no less than 7%, a handsome long-term net return. Both the donor and the school were pleased–the proverbial win-win.
Issues to consider
Insurable interest is the first planning aspect that must be confirmed. In my example, the donor had not only graduated from the school; he had two children who had gone there and served on the school’s board. Most importantly, he had a long track record of giving, both annually and during campaigns. The Truth is, the school would suffer a financial loss at his death.
It is very important that you understand the relationship of your client (the donor) with the charity so you can justify the insurable interest to the underwriter(s) at the carrier(s). Do this first-don’t just assume anyone with a charitable intent can acquire life insurance because they want to; insurable interest laws were established for a good reason. Also, you don’t want to excite clients by the idea of gifting, only to find they just started working with a charity or there is not enough history to justify insuring them.
It would be easy to assume that your client can take a full tax deduction for a planned gift of life insurance, but don’t assume. Confirm it with a tax professional, so there are no surprises.
In addition to insurability, the client’s specific rating classification makes a real difference in charitable planning. Today, most carriers have as many as five standard or better ratings. Each improvement in the underwriting class means savings for the donor and/or a greater gift to the charitable organization.
Thus shopping for multiple carriers is key, as those with standard and preferred “plus” ratings can create significant savings over a carrier offering only standard and preferred rating classes. However, this theory must be tested, as costs will differ. A market analysis is the only way to find the best product choice for the client.
You must also help clients budget for a policy acquisition, both for the short and long term. Don’t assume that because individuals of means are making a planned charitable gift that they will want to pay the premium forever, or that they won’t ever have cash-flow issues. Therefore, be wary of no-lapse guarantee universal life products that offer little premium flexibility if a donor ceases payments. Also, remember the charity will own the policy and may need to cash the policy in before it matures. So building up cash value is key.
Whole life, as an alternative to UL, may not give enough flexibility either; and a variable life product that sees down markets may affect the expectations of the donor and the charity too much. We’ve achieved the greatest success using life insurance for charitable purposes with a traditional universal life product that offers good cash accumulation until late in life, but that also (to keep the premium reasonable) does not require funding until the policy endows.
This policy type strikes a reasonable balance between keeping the premium low while building a cash value cushion that may be needed to meet temporary needs, maintain the policy in the event of missed premium payments or accommodate a decision by the charitable institution to cash out early. Talk through these issues with the donor and the charity so proper planning can be implemented.
Vernon W. Holleman, III, is president of The Holleman Companies, an insurance advisory firm based in Chevy Chase, Md. He can be reached at [email protected].