life insurance in charitable planning

Using Life Insurance in Charitable Planning

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1.Wealth

replacement

2.Gifting existing policies

3.Creating new policies for the charity

Common Uses

Using life insurance as wealth replacement in charitable planning

Part I

Charitable planning devices such as Charitable Gift Annuities, Gifts of Remainder Interests in Homes and Farms, and Charitable Remainder Trusts produce amazing tax advantages, reducing income taxes, capital gain taxes, and estate taxes

But, they also reduce heirs’ inheritance

Heir Charity Donor

Life insurance can diminish this concern

1. Anything you own is taxable at death unless it goes to a spouse or charity

2. If your life insurance is owned by another person or an Irrevocable Life Insurance Trust (ILIT) it is not taxable at your death (unless policy given in prior 3 years)

Estate tax law made simple

Parent

Money to Pay Premiums

Insurance Inc. Because the parent does not own the policy, it is not taxed in his estate

Child

Policy on Parent’s

Life

Premium Payments

Estate Tax Free Death

Benefit

Irrevocable Life Insurance Trust

(ILIT) Parent Child



Life

Because the parent does not own the policy, it is not taxed in his estate

Insurance Inc.

Premium Payments


Benefit


(ILIT) Parent Child



Life

Insurance Inc. The parent can use the tax benefit or income from a CGA or CRT to pay for life insurance

Premium Payments


Benefit


(ILIT) Parent Child



Life

Insurance Inc. Charitable Remainder Trust (CRT)

Premium Payments


Benefit

Tax Deduction + Ongoing Income


(ILIT) Parent Child



Life

Insurance Inc. The child gets a tax free inheritance instead of losing up to 40% in estate taxes

Premium Payments


Benefit

We give the taxable inheritance to charity, and create income to purchase the non-

taxable inheritance to give to children


(ILIT) Parent Child



Life

Insurance Inc.

Premium Payments

Gifts for premiums can be gift tax free if ≤ $14,000 X beneficiaries X donors annually. (E.g., 2 parents to 2 children, spouses, and 4 grandchildren: 2 X 8 X $14,000 = $224,000) Estate

Tax Free Death

Benefit

Can it pay to be charitable?

Priscilla wants to sell a $1,000,000 non-income producing zero-basis asset then spend the interest income of 5% while leaving principal for heirs. Her tax rates are: capital gains (23.8%) income (39.6%) estate (40%)

Sale $1,000,000 asset -$238,000 capital gains tax Client uses $38,100/year ($762,000 X 5% return) Heirs receive $457,000 ($762,000-$304,800 est. tax)

CRUT $1,000,000 asset $0 capital gains tax

$1,000,000 in 5% unitrust pays $50,000 annually + a charitable tax deduction of $300,000 worth $118,000

+ ILIT Client pays $118,000 initially and $11,900 annually for a $457,000 ILIT-owned policy

Client uses $38,100/year Charity receives $1,000,000 remainder Heirs receive $457,000 (tax free from ILIT)

John, age 59, at 39.6% income tax rate, owns $100,000 of farmland which he would like to use for the rest of his life then leave to charity, but he also wants to benefit his heirs

Donor can use tax deduction to buy tax free life insurance (ILIT) for children’s inheritance

Giving the remainder interest to charity creates a deduction of $80,479 worth $32,869. Suppose this will purchase a paid-up policy of about $50,000+. (Using 1% AFR, however policy costs and deduction size offset as interest rates change)

John keeps lifetime use of farm Charity gets 100% of farm at death Heirs get $50,000+ (estate tax free)

Wealth replacement through ILIT life insurance creates estate tax free

inheritance for family members and allows for charitable giving

Donor CRT Charity

Initial Transfer

Anything Left after Death of

Donor and Kids

Payments During

Donor Life

Donor kids

Payments after Donor’s Death, During

Kids Lives

Donor CRT Charity

Initial Transfer

Anything Left at Death

Payments During Life

Donor CRT Charity

Initial Transfer


Donor and Spouse

Payments During

Donor Life

Donor’s spouse

Payments after Donor’s

Death for Spouse’s Life

Donor CRT Charity

Initial Transfer


Donor and Kids

Payments During

Donor Life

Payments after Donor’s

Death for Kid’s Lives

Donor kids

Donor CRT Charity

Initial Transfer


Donor and Kids

Payments During

Donor Life

Donor kids


Kids Lives


Kids Lives

Donor CRT Charity

Initial Transfer


Donor and Kids

Payments During

Donor Life

Donor kids ILIT At donor death,

pays annuity

Donor CRT Charity

Initial Transfer


Donor and Kids

Payments During

Donor Life

Donor kids ILIT At donor death,

pays annuity

Structure of the ILIT


(ILIT) Parent Child


Premium Payments Estate Tax

Free Death Benefit


Life

Insurance Inc. Donor cannot be ILIT trustee, otherwise in donor’s estate


(ILIT) Parent Child



Free Death Benefit


Life

Insurance Inc. Gifts to the ILIT are taxable, thus can reduce the available credit for estate tax purposes


(ILIT) Parent Child



Free Death Benefit


Life

Insurance Inc. Gifts to the ILIT are not “present interest” gifts, because recipients have to wait to receive benefit


(ILIT) Parent Child



Free Death Benefit


Life

Insurance Inc. We turn the gifts into “present interest” gifts by giving beneficiaries the temporary right to get the gift in cash


(ILIT) Parent Child

Money to Pay

Premiums


Benefit Policy on Parent’s

Life

Insurance Inc.

Premium Payments

30 day right to take gift as cash

We turn the gifts into “present interest” gifts by giving beneficiaries the temporary right to get the gift in cash


(ILIT) Parent Child

Money to Pay

Premiums



Life

Insurance Inc.

Premium Payments


This temporary right to get the gift in cash is called a “Crummey” power

Of course, we explain to the beneficiary it is best not to take the cash and destroy the planning

I don’t feel like using my “Crummey” power to take the cash immediately


(ILIT) Parent Child

Money to Pay

Premiums



Life

Insurance Inc.

Premium Payments


Gifts for premiums can be gift tax free if ≤ $14,000 X beneficiaries X donors annually


(ILIT) Parent Child

Money to Pay

Premiums



Life

Insurance Inc.

Premium Payments


2 parents to 2 children, spouses, and 4 grandchildren 2 X 8 X $14,000 = $224,000 per year using “Crummey” powers

$224,000 per year can pay for a lot of

estate tax free life insurance


(ILIT) Parent Child

Money to Pay

Premiums



Life

Insurance Inc.

Premium Payments


The “Crummey” power creates another problem


(ILIT) Parent Child

Money to Pay

Premiums



Life

Insurance Inc.

Premium Payments


When the beneficiary chooses not to take the cash, he makes a gift to the other trust beneficiaries


(ILIT) Parent Child

Money to Pay

Premiums



Life

Insurance Inc.

Premium Payments


This gift is not a “present interest” gift, and will reduce the beneficiary’s available estate tax credit


(ILIT) Parent Child

Money to Pay

Premiums



Life

Insurance Inc.

Premium Payments


But, beneficiary can release greater of $5,000 or 5% of trust amount tax free


(ILIT) Parent Child

Money to Pay

Premiums



Life

Insurance Inc.

Premium Payments


One solution: beneficiary retains right to demand cash, except for $5,000/5% annual release (a.k.a. “hanging power”)


(ILIT) Parent



Free Death Benefit


Life

Insurance Inc.

Grandchildren

Not generation skipping transfer tax free unless separate ILIT for each grandchild (included in each grandchild’s estate)

ILIT-CRT planning creates flexibility

CRT reduces inheritance

Use part of CRT payments or tax deduction for ILIT

CRT can pay to children but creates estate taxes

Remove children CRT beneficiaries, increase CRT payments to pay for tax free ILIT owned life insurance for children

Part II

Giving existing life insurance policies to charity

•Bought too much insurance for actual or current needs

•Bought for children who are no longer dependent

•Bought for an outdated business buy-sell

agreement

•Doesn’t need the cash value

Giving a life insurance policy means giving all rights to the charity

• No incidents of ownership

• No ability to borrow or change beneficiaries

• No indirect benefit to donor

Typical policy gift valued at lower of these

How do we calculate fair

market value or donor’s basis?

Uncertainty in Basis Valuation

For payments from insurance company

Basis = + premiums paid – refunds – loans

For sales to others

Basis = + premiums paid – refunds – loans –“Cost of insurance” (term portion of policy)

Uncertain for charitable gifts Will “cost of insurance”

reduction fail in court review? Will it apply to gifts?

For universal life policies, “Cost of Insurance” is reported to the policyholder. For traditional whole life policies, “Cost of Insurance” may not be reported or easily determined. For term insurance, “Cost of Insurance” is the premium.

Typical fair market value

Premiums due policy: ≈ cash surrender value, greater of ITR (n/a variable or universal life) + or PERC Newly issued policy: use first premium paid for fair market value Paid-up policy: replacement policy for insured of that age

Because of the “life settlement” market,

policies may have value far beyond

traditional calculations

Life settlement value above cash surrender value is

probably deductible as long-term capital

gain

Life settlement value up to cash

surrender value is ordinary income and

deductible only at basis

$150,000 life settlement value

$50,000 cash surrender value

$20,000 basis

Deduction would likely be $20,000 + $100,000

Summary of qualified appraisal attached to tax return

Note from charity before taxes filed or due

(1) Date, location, and description of property

(2) “No goods or services were provided in exchange for these gifts.” [or describe and value items provided]

Donor’s reliable records of gift, charity, date, place, FMV (and cost basis if relevant)

Neither the insurance agent who sold the policy nor the insurance company may prepare the appraisal because they are parties to the transaction

Donating a policy with outstanding loans is

bad planning!

• Under charitable split-dollar rules the deduction (for gift or future premiums) will be entirely lost

• Donor is taxed on ordinary

income in the amount of loan less the applicable basis, which is loan amount X (policy basis/policy FMV)

Don’t give life insurance with outstanding loans!

After getting a policy the charity may

• Ask donor to continue to pay premiums

• Surrender for cash value

• Pay premiums from charity’s funds

• Sell in the life settlement market

Annuity contracts may be poor gifts • Donor will immediately

recognize all gain in contract as ordinary income

• If issued pre-1/23/87 and not matured deduction limited to cost basis

• Gifting at death is not a problem

Part III

Creating new policies for the charity

Insurance Inc.

Creation or Transfer of New Policy

2014

Gifts to be used for premiums

Death Benefit

to Charity

Option 1: Donor makes gifts to be used as premium payments

Gifts are deductible if donor keeps no rights in the policy

2015 2016 2017 2018 … Death

Insurance Inc.


Premium Payments

Death Benefit

to Charity

Option 2: Donor pays premiums on charity-owned policy

Gifts are deductible if donor keeps no rights in the policy

2014

2015 2016 2017 2018 … Death

Insurance Inc.



Death Benefit

to Charity

1. Deductible so long as donor retains no rights in the policy

2014

2015 2016 2017 2018 … Death

Insurance Inc.


Premium Payments

Death Benefit

to Charity

2. Deductible so long as donor retains no rights in the policy

2014

2015 2016 2017 2018 … Death

Insurance Inc.



Death Benefit

to Charity

1. Standard gift receipt

2014

2015 2016 2017 2018 … Death

Insurance Inc.


Premium Payments

Death Benefit

to Charity

2. Gift receipting practice depends on charity

2014

2015 2016 2017 2018 … Death

Insurance Inc.



Death Benefit

to Charity

1. Donor can give appreciated property

2014

2015 2016 2017 2018 … Death

Insurance Inc.


Premium Payments

Death Benefit

to Charity

2. Donor must give cash

2014

2015 2016 2017 2018 … Death

Insurance Inc.



Death Benefit

to Charity

1. Income limitation of 50% for cash gifts

2014

2015 2016 2017 2018 … Death

Insurance Inc.


Premium Payments

Death Benefit

to Charity

2. Income limitation of 30% “for the use of” charity

2015 2016 2017 2018 … Death

2014

Insurance Inc.



Death Benefit

to Charity

• Standard gift receipt • Can give appreciated property • 50% income limitation for cash

2014

2015 2016 2017 2018 … Death

Insurance Inc.


Premium Payments

Death Benefit

to Charity

2015 2016 2017 2018 … Death

2014

• Gift receipting depends on charity • Must give cash • 30% income limitation for cash

Potential advantages and problems for charities and donors

Donor with small income can fund a large posthumous

project

Potential advantages

Donor receives a bill from the life insurance company instead of ongoing donation requests from charity


Insurance agents may help to “sell” the idea instead of requiring charity fundraiser time


Insurance agents may “oversell” risking long-term donor relationships

Potential problems

Depending on policy structure, donor may give for years, and charity receives nothing due to later policy lapse

Potential problems

Some policies may benefit insurance companies and agents more than charity

Potential problems

Potential problems:

Insurable interest (i.e., you can’t take out a life insurance policy on a stranger)

Has now mostly been fixed by legislation

The charity may prefer funds today

Potential problems

The donor never sees the impact of the gift

Potential problems

Donors cannibalize giving to pay premiums

Regular giving to charity

Premium Payments

Potential problems

A charity can prevent problems by refusing to accept policy gifts that don’t meet its guidelines. Assume cannibalization of gift income and require

• Short-term (e.g., 10 year) to projected paid up status to age 100

• Top companies • Reasonable interest

rate projections

Otherwise, just say “No!”

It isn’t “free” if the donors will be paying premiums instead of giving to your organization

1.Wealth

replacement

2.Gifting existing policies

3.Creating new policies for the charity

Common Uses

Using Life Insurance in Charitable Planning

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This slide set is from the curriculum for the Graduate Certificate in Charitable Financial Planning at Texas Tech University, home to the nation’s largest graduate program in personal financial planning. To find out more about the online Graduate Certificate in Charitable Financial Planning go to www.EncourageGenerosity.com To find out more about the M.S. or Ph.D. in personal financial planning at Texas Tech University, go to www.depts.ttu.edu/pfp/

Graduate Studies in

Charitable Financial Planning at Texas Tech University

http://www.encouragegenerosity.com/

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life insurance in charitable planning

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