How can a gift of Life Insurance be used for charitable planning?

Old man walking in a green field during the sunset in the countryside.

Many planners agree that Life Insurance is one of the best gifts to give to heirs rather than charities.  Why?  Life insurance passes income tax free to the beneficiary.  Yes, the Life Insurance will be included in the value of the owner’s estate at time of death, but it does flow INCOME tax free to the heirs.  So why would one want to give a life insurance policy to a charity rather than heirs?

There can be many reasons. Let’s explore a couple:

Life insurance is not needed any longer: Perhaps the owner purchased the life insurance years ago for family protection or for estate tax reasons.  The need from years ago may have changed.  The estate tax rules have significantly increased the amount a person can pass without federal estate tax.  Perhaps the family has now out grown up, and the original policy is no longer needed.   Whatever the reason, the older life policy can make a great charitable gift.   In these examples the owner of the policy could simply transfer the ownership to a charity. The Life Insurance Company would calculate for the donor, the deduction that the donor would receive (may times we think it is the cash value, but it is not as simple as that, seek professional advice on calculating the deductible value).  If the policy has an ongoing premium, part of the donor’s plan would be to continue making gifts to the charity in the future, equal to the amount of the premium.  This future gift would also be deductible to the donor.  If the policy no longer requires a premium, then no future gifts would be needed.

At the death of the insured, the charity would receive the death benefit of the policy. This would not be a taxable event to the charity.

Example of Paul age 75.  Paul has a life insurance policy with a death benefit of $150,000.  It was purchased years ago when he was much younger and of good health, for protecting his family if he would have died prematurely.  Throughout Paul’s life he paid a premium of $100 a month for the last 45 years.  His total cost basis is $54,000.  The cash value of the policy is now $130,000.   Paul does not need the policy any longer as the kids are grown and on their own and his wife passed away a couple of years ago.  Paul had been meeting with his advisor updating his will when he shared a desire to create a scholarship fund at the school where his wife taught for most of her career.  Paul’s advisor noticed that he has the life policy from back when he was 30 years old and he had faithfully applied $100 a month thinking that this would be a source of extra income in his retirement years.   After thinking about it, Paul decided he really didn’t need the cash, nor did he want to surrender the policy and have the tax gain of $76,000 ($130,000 cash value - $54,000 cost basis).  His first thought was just change the beneficiary to the school foundation and create the scholarship fund that he had been thinking about.   This would have been a great plan if it ended there, however after more thinking, here is how the plan ended up.

Paul transferred the ownership of the life policy to the school foundation.  This generated a tax deduction of nearly $130,000 (remember there is a special calculation to use) to Paul to help him offset some taxes.  He was not able to use the full deduction this year, so it will carry forward for up to an additional 5 years.

The school foundation now owns the policy, which is paid up and no further premiums are due. When Paul passes away the school foundation will file a claim with the insurance company and receive the full death benefit at that time to fund the scholarship that Paul created to honor his spouse’s career.  Many future students will be impacted by this gift for years to come!

Leveraging an unneeded Roth IRA:

Meet Mary age 70 who faithfully funded a Roth IRA the last 10 years of her career.  Her deceased spouse had done the same.  Between the two of them they had accumulated $100,000 in Roth IRA’s.  Mary is young but lives a frugal lifestyle in rural Minnesota. She enjoys volunteering at the local hospice house where her spouse lived the last months of his life.  Mary has a good income stream from Social Security, farm rent, and a pension from the post office.  Mary is very confident that the only reason she will ever use her Roth IRA is if her health declines and she needs extended care.  However, Mary did purchase Long Term Care Insurance years ago when it was offered as a benefit through the post office.  With this LTC contract and her guaranteed income sources, she is very confident that she will not use her Roth IRA.  Mary was talking with her financial advisor and expressed the idea of wanting to leave something to the hospice house, library and church someday when she passed away.  The simple answer was to name these charities as beneficiary on the Roth IRA contract.  This would leave the Roth for Mary if she ever did need the money, which Mary agreed was highly unlikely.

After thinking this scenario through, the advisor suggested Mary take the gain from the Roth of approximately $5,000 each year and fund a life insurance policy.  This would be a way to leverage the growth of the Roth and create a potentially larger death benefit to support the three charities.  Mary was of good health and this seemed like an idea to explore.  The advantage was that Mary was able to purchase a $100,000 life insurance contract with the $5,000 a year premium.  In this example Mary used a whole life policy so that if she ever needed to stop paying the premium she could take a reduce paid up policy. The nature of the whole life policy also perked up Mary’s interest in knowing that the death benefit might grow over time with dividends leaving more for the charities.

The result, Mary continues to have approximately $100,000 in a Roth IRA that she would be able to access in the future if she needed it PLUS there is a $100,000 life insurance policy that Mary owns which will benefit the 3 three charities that are near and dear to her when she passes away.  Keep in mind Mary does have the 3 three charities listed as beneficiary of the Roth IRA account and the whole Life policy could continue to grow over time with dividends.

Mary could have taken this a step further and she might do this in the future.  She could have transferred the life policy to the charity to own so that the annual premium she pays would be tax deductible to her.  In this case Mary chose not to do this yet because of the Tax Reform Act and her higher standard deduction she is not able to deduct the $5,000 premium.  She will reevaluate this in 2025 when the Tax Reform is subject to reverse back to a lower standard deduction.

Another plus for Mary is that taking the $5,000 of gain from the Roth IRA each year, is not a taxable event to her!  Keep in mind that the Roth IRA and the life policy, both passing by beneficiary to the charities would create a tax deduction to her estate in the future as well.

In Summary: Life insurance is a great vehicle to pass income tax free dollars to heirs. However, it can also make a great charitable gift.  With detailed planning there are multiple ways to leverage life insurance for charitable gift planning.

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