Tax Article - Life Insurance Leads Way to Charitable Contribution

Tanya is a recent divorcee who’s looking for ways to renew her life. One of her goals is to give more back to her local community. When she mentioned her desire to somehow give to a local charity in a manner more substantial than a simple cash donation, her financial advisor mentioned life insurance.

As it turns out, Tanya had a permanent life insurance policy that she didn’t need for herself. So her advisor explained that it could make the perfect vehicle for fulfilling her charitable aspirations while preserving her estate.

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How it Works

Giving life insurance to a charity can be as simple as designating the charitable organization as beneficiary of the policy in question. On the policy owner’s death, the charity would receive the policy proceeds.

Tanya could go one step further and irrevocably give the policy to the organization by naming the charity as the policy owner. Because she’d be donating a permanent (rather than term) life insurance policy, the charity could enjoy the policy’s accrued cash value at its own choosing.

Tanya wondered about the annual policy premiums. Her advisor explained that, by paying them, she’d essentially be making a substantial donation on an installment plan.
This would be particularly beneficial for her charity of choice should Tanya die relatively soon after donating the policy. Why? If, for example, Tanya paid $5,000 annual life insurance premiums and died two years after donating the policy, the charity would receive the policy’s full death benefit. But if instead of donating a life insurance policy she simply pledged a series of $5,000 annual cash donations, the donations would stop at her death and the charity would have received only $10,000 total.

What the Tax Consequences Are

The tax ramifications of donating life insurance vary depending on the circumstances. If Tanya gave the policy itself to the charitable organization, she would garner a current income tax deduction on the donation of the policy (equal to the lesser of her cost basis or the policy’s value) and on each premium payment. (Part or all of these deductions might, however, have to be carried over to a future year if her total charitable donations for the year are significant.)

Of course, if Tanya opted not to give her actual policy to the charity but simply make it the beneficiary, she couldn’t deduct her annual premiums. On the plus side, by retaining policy ownership, she’d still be able to access the policy’s cash value if she needed it or change the beneficiary if her family’s circumstances or her charitable wishes changed in the future.

Regardless of whether she donated the policy itself or simply named the charity as beneficiary, she’d reap estate tax benefits. In both situations, the proceeds paid to the charity at her death wouldn’t be subject to estate tax.

Who Can Help?

In closing, the advisor mentioned that there were other details Tanya would have to consider. For example, the IRS requires defensible appraisals of all charitable contributions over $5,000 other than cash or marketable securities, including life insurance policies. She thanked him and assured him that she’d look to him for help if she decided to pursue the idea.

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