In the fall of every year, financial advisors often address their clients’ year-end planning, including opportunities for charitable giving. With asset values rising for some clients, charitable planning may be back as an attractive planning opportunity in 2016.
This article summarizes four planning strategies for clients (referred to as donors for purposes of this article), showcasing popular uses of life insurance in connection with charitable planning.
(1) Name the charity as the policy’s beneficiary
If the charity is named as the beneficiary, the donor will not receive an income tax deduction for premiums paid, but will have the ability to change beneficiaries later, generally with no estate tax consequences.
(2) Gift existing policy to charity
A donor may choose to gift an existing policy to charity outright by transferring ownership of the policy to the charity. In this case, the maximum allowable deduction will be limited to the lesser of the fair market value of the policy or its cost basis.
In addition, the donor should be certain to gift his/her entire interest in the policy. Finally, the charity must have an insurable interest in the donor under applicable state law.
Many other factors limit the actual amount of the deduction which may be taken in any one tax year, including whether the charity is public or private and the donor’s adjusted gross income. As in all cases involving complex planning, donors should seek the advice of their tax attorney and/or CPA for an analysis of the tax consequences given their particular circumstances.
(3) Allow charity to purchase a new policy and make premium gifts
If, on the other hand, the donor allows the charity to purchase a new policy to the charity and gifts the premiums, the donor will generally receive an income tax deduction for the initial premium amount and the additional premium amounts. But the donor won’t have the opportunity to change beneficiaries later because the charity is the owner of the policy and retains all ownership rights.
As in the case of gifting the policy, the charity must have insurable interest under applicable state law. The actual amount of the deduction for the client will depend upon the donor’s facts and circumstances.
With regard to underwriting new policies owned by charities, financial advisors should familiarize themselves with the financial underwriting guidelines of the insurance carriers considered for the coverage. The financial underwriting guidelines for carriers vary.
A donor can purchase life insurance to replace the amount of wealth given to a charity, writes Brett Berg. (Photo: Thinkstock)
Some common financial underwriting guidelines include, but are not limited to:
The face amount will generally be limited to a multiple of the donor’s giving history to the charity;
The donor may need to demonstrate an established ongoing relationship with the charity; and
The donor may need to demonstrate that the client has taken appropriate steps to satisfy other insurance needs for his/her family before helping the charity establish a policy on the donor’s life.
(4) Use life insurance to replace gifted wealth
A donor may also want to give other assets to charity either during life or at death. In these situations, a donor may want to purchase life insurance to replace the amount of wealth given to the charity. Such gifting strategies vary in their complexity.
To illustrate a fairly simple and straightforward case, let’s assume we have a couple, Harry and Wendy, both in their 50s and in good health. Harry works as a teacher and Wendy is a doctor. They have one son, Sean. Harry and Wendy have a $4 million estate, including a $500,000 IRA.
Harry and Wendy determine that, in their plan, they want to use the IRA while living, including potentially rolling over the IRA to Wendy if Harry dies. After they both die, they want to give away the $500,000 IRA to the hospital foundation.
They want to replace the wealth given away with a $500,000 life insurance policy payable to Sean. So they purchase a $500,000 survivorship policy, owned individually by Harry with contingent owner Wendy and with the beneficiary Sean. Instead of an income taxable IRA, Sean will receive income tax-free life insurance proceeds.
A more complex strategy may involve the use of a charitable remainder trust (CRT) combined with an irrevocable life insurance trust (ILIT) to replace the wealth given away.
A CRT is an irrevocable trust to which a donor makes a contribution and retains an income interest. The charity, as remainder beneficiary, gets whatever is left in the trust upon the expiration of the donor’s income interest (which can be a term of years or the entire life of the donor). The donor is entitled to a current income tax deduction for the present value of the remainder passing to the charity.
A more complex strategy combines a charitable remainder trust (CRT) with an irrevocable life insurance trust (ILIT) to replaced gifted wealth. (Photo: Thinkstock)
Important reasons that donors fund a CRT may include:
If capital gain property is transferred to the trust, the donor is generally entitled to an income tax deduction based upon the full fair market value of the asset even though he or she has never paid income taxes on the built up capital gain; and
the trustee of the CRT can sell capital gain property without recognizing any income (capital gain) tax upon the sale.
Given the 2016 performance of the stock market and rising asset values for many prospective donors, a CRT may be an attractive planning vehicle to review and to discuss — and life insurance can play an important role in the discussion.
If donors choose to establish a CRT and, for example, gift part of an appreciated stock portfolio to the CRT, they could consider replacing that wealth with life insurance, often owned in an irrevocable life insurance trust, sometimes referred to as a wealth replacement trust. In addition to advising on the tax consequences of the transactions, the donors’ attorneys draw the trusts to implement the plan.
For many clients this fall, charitable giving may be top of mind. Financial advisors should consider discussing with prospective donors the use of life insurance within an overall gifting strategy to enhance their charitable giving plans.
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