Six Ideas to Facilitate Charitable Giving with Life Insurance
By Jerry Borrowman, CAP (Chartered Advisor Philanthropy)
1. A Legacy Gift to Charity
Several years ago, I wrote a $20,027 check to the American College in Philadelphia, where I received my master’s degree in financial services (MSFS). The purpose of the gift was to support their endowment fund. My after-tax cost was $13,418. Because Pennsylvania allows a charity to have an insurable interest in a donor, I also authorized the college to use the money to purchase a $100,000 single premium life insurance on my life that is guaranteed through age 121 with no future payments required.
In other words, for just 13 cents on the dollar, I guaranteed the college $100,000 at my death. The average annual internal rate of return on this purchase is greater than 6 percent tax-free at age 86, my normal life expectancy. It is difficult for a charity to find a no-risk investment at 6 percent or higher in today’s low-interest-rate environment, so the college has a superior return with no risk. More than that, the cash value and present value of the future death claim are assets that strengthen the college’s balance sheet for many years to come.
A single-premium policy is attractive to a charity because there is no risk of the policy becoming underfunded—it is fully paid-up by the initial gift. But it is not the only way to use life insurance to create a charitable legacy. Donors can make annual tax-deductible gifts to fund a life policy with the charity as owner and beneficiary.
- Some states assign an insurable interest to a charity, while others, including Utah, do not.
- In states where charities have an insurable interest, the charity can purchase the policy as owner and beneficiary. The donor is the insured. The donor makes cash gifts to the charity, which are used to pay the premium.
- In states where charities do NOT have an insurable interest, the donor would purchase a policy with a personal beneficiary. After paying a number of premiums, the donor can donate the policy to the charity because insurable interest only applies at the time a policy is purchased.
- Charities, including The Church of Jesus Christ of Latter-day Saints, almost always have a “gift acceptance committee” to decide whether to accept different kinds of gifts, including life insurance. Charities are highly likely to accept a single-premium policy that is fully funded. They will consider whether or not to accept an annual premium policy where future funding is uncertain.
There are a lot of choices—too many for this newsletter—but just know that you can do something really magnificent for your favorite charity by creating a legacy with life insurance at an affordable out-of-pocket, tax-deductible contribution.
2. Replacement Asset for Family Beneficiaries Disinherited by a Charitable Remainder Trust
A charitable remainder trust (CRT) allows a donor to sell an appreciated asset that will ultimately transfer to a charity, while retaining a term or lifetime income interest from the sale of the asset.
- The donor donates an appreciated asset to a trust created specifically for the donor and his or her family. This may be a business interest, real estate, appreciated stock, and so on.
- Once owned by the trust, the trustee (who is often the donor) sells the asset with no capital gains tax due because the ultimate recipient of the “remainder” interest is a qualifying charity.
- This leaves more money to produce a lifetime (or period-certain) income to the donor and spouse, or to other named beneficiaries.
- At the end of life or term, the balance is given to the charity named in the trust.
- Additionally, there is a current income tax deduction that can offset earned income for up to six years based on the amount given to the trust.
Problem? Not for the donor who wants to sell an asset and live off the income—because with all the tax savings, the donor and spouse will have a higher lifetime income than if they did not use the trust. But what about the heirs of the donors since the remainder interest goes to a charity instead of the children?
It turns out that the income tax savings created by the gift to the CRT is often large enough to fully fund a life insurance policy that is equal to the amount of money the children would have inherited if all the taxes had been paid at the time of sale. In other words, the donor gets both a tax-deduction and avoidance of capital gains recognition, the charity receives a large endowment at the end of the CRT term, and the beneficiaries receive an income-tax-free (and potentially estate-tax-free) life insurance death benefit as a substitute for inheriting the proceeds of the sale. And the life insurance is funded by tax savings!
3. Estate Tax Funding for Assets Returned to Estate from Incomplete CLT
A charitable lead trust (CLT) is sometimes called the “nuclear option” of estate planning since it allows the transfer of large property or business interests to children free of estate and gift taxes. The owner of the property transfers it for a limited number of years to a CLT that, when complete, will distribute the property to the children. Large discounts are available because the transfer to the children is delayed. Also, the amount that is subject to gift taxes is reduced by the amount of income the trust will make to a charity each year of its term. The property moves to the children with substantial discounts. But there is a catch; if the grantor of a charitable lead trust dies before the lead interest is complete, the assets come back into the taxable estate. Since a lead trust often lasts for a decade or longer to achieve maximum tax savings, if the grantor dies during the term of the trust, a life insurance policy can pay the estate taxes caused by this reversion.
4. Investment Funding of Charitable Remainder Trusts
Speaking of charitable remainder trusts, life insurance and annuities can provide lifetime income from a charitable remainder trust for the split-interest income beneficiaries. Insurance and annuities are particularly helpful when funding a NIMCRUT (net income with makeup provision charitable remainder unitrust) since the CRT trustee can postpone making payments to the grantor in any year that the trust does not have taxable income. Since life insurance and annuities have the benefit of tax deferral, in which annual increases in cash value are not taxed until withdrawn from the policy, the trustee can accumulate income for as long as desired, then start paying income (including income payments missed during deferral) by taking strategic withdrawals from the insurance and annuity. And in the current interest rate environment, life insurance policies and annuities have competitive returns on cash value compared to other safe choices.
5. Endow Your Annual Charitable Contribution
Case study: Consider a donor who contributes $20,000 per year to the Church, perhaps to the Perpetual Education Fund or to a Church educational institution like BYU, BYU–Idaho, or BYU–Hawaii. The donor feels a great deal of loyalty to the charity and has announced his intention to contribute “till the day I die!”
You share the following idea with the donor, who is a non-tobacco user and is in good health: “If are in a position to contribute an extra $4,000 per year (approximately 20 percent more than your current contribution), you could purchase a $400,000 no-lapse universal life policy that is guaranteed for your life and then donate it to the Church or to the educational institution, along with a commitment to continue a cash contribution equal to the premium.”
At the donor’s death, the Church or the educational institution receives $400,000 from the life insurance company and invests it to earn 5 percent per year.
- 5 percent of $400,000 = $20,000.
Thus, if the charity were able to maintain 5 percent income from investing the death benefit, the annual transfer to BYU or the other supported charity continues beyond the donor’s death for perpetuity. It is no longer a “till the day I die” gift but rather a forever gift.
6. IRA and Life Insurance
A client who owns an IRA desires to leave legacy to both her family and to a Church-sponsored charity. Why not donate the IRA to the charity at death to avoid income taxation to the heirs because of “income in respect of a decedent” rules? The charity receives the IRA free of both income tax and estate tax. Meanwhile, required minimum distributions from the IRA during the life of the donor can purchase tax-free life insurance that goes to the heirs at death—a double legacy from the IRA to the Church and to children and grandchildren.
I hope these ideas give at least a small sense of the power of life insurance to facilitate virtually every other planned giving strategy, such as charitable trusts, donor advised funds, family foundations, legacy gifts, and lifetime gifts. It really is a remarkable tool in the charitable giving toolkit. Please reach out to your contact at the Philanthropy Department of The Church of Jesus Christ of Latter-day Saints for a more in-depth discussion of these tools and how they might apply to you. Or feel free to give me a call at 801-949-2984 or by email at email@example.com.
About the Author
Jerry Borrowman has been a member of the Planned Giving Design Council Board for more than a decade. He has been a life insurance professional for 42 years, working as an agent, trainer, and home office employee for New York Life, Beneficial Life, and Penn Mutual. He is currently director of advanced markets at Cambridge Financial Group in Utah, Arizona, Nevada, Idaho, and Colorado. He is a nationally recognized speaker and was the 2017 recipient of the Lifetime Achievement Award from the Utah Chapters of the Society of Financial Services Professionals and the National Association of Insurance and Financial Advisers which was presented at a ceremony at Brigham Young University.
Jerry is also a well-known author of historical biography, nonfiction, and fiction, with 18 books published, most by subsidiaries of Deseret Book. He is the two-time recipient of the George Washington Medal of Honor from the Freedom’s Foundation at Valley Forge for his patriotic writing. You can learn more about his books at www.jerryborrowman.com or at www.deseretbook.com.