CGNA: Chapter 6 - Life Insurance, Advanced - Part 1 of 3

CGNA: Chapter 6 - Life Insurance, Advanced - Part 1 of 3

Article posted in General on 27 June 2018| comments


We conclude our series on gifts of life insurance with more advanced ideas and explanations.

This article is an excerpt from Charitable Gifts of Noncash Assets, a comprehensive guide to illiquid giving by Bryan Clontz, ed. Ryan Raffin. Published by the American College of Financial Services for the Chartered Advisor in Philanthropy Program (CAP), with generous funding from Leon L. Levy. For a free digital copy, click here, and to order a bound copy from Amazon, click here.

Below is an in-depth examination on gifts of life insurance2. Life insurance topics are based on my article, “Charitable Gifts of Life Insurance: The Lone Ranger or Black Bart.” For quick take-aways on gifts of life insurance, see Life Insurance Quick Take-Aways. For a review based on that article, see Life Insurance Intermediate. For an in-depth examination adapted and excerpted from the article, see Life Insurance Advanced. For further details, see Life Insurance Additional Resources.

Life insurance is one of the most mercurial of gift planning vehicles. To some, it is an elegant and simple way to capture a fixed amount that exactly matches the donor’s intent. To others, it is a complex way to book gifts now that result in no eventual gift, potential litigation and/or never-ending management problems.

This discussion is not intended to take one position or the other. Rather, it is a survey piece intended to discuss and explain each of these three distinct categories—“Tried and True,”“Black and Blue,” and “It’s Up to You.”These sections are followed with a “Things You Must Do” section, where critically important pre- and post-gift acceptance issues will be covered.

“Tried and True”

When life insurance policies are donated to charity, boring is nearly always best.

Why would a donor want to do this? She may have a policy she no longer needs, or a specific dollar amount she wishes to contribute no matter what happens. Or she may have more insurance than she currently wishes for her beneficiaries, or she may wish to provide more to her beneficiaries, should she choose to give away some assets. Or finally, the charity itself may wish to use insurance to protect itself against the prema- ture death of a major donor or perhaps to cover its liability for a gift annuity. Here are some brief, but not all-inclusive, options.

1. Existing Policy Donation—A simple process where the owner of the insurance policy absolutely assigns all rights in the policy to the public charity. Because life insurance is ordinary income property, the IRS limits the deduction to the lesser of fair market value or adjusted cost basis. The policy may be paid-up, where no additional premiums are due. Or non- paid up, which means someone will need to make additional premiums.

Nugget #1: If the policy’s value is greater than $5,000, a qualified appraiser must complete a qualified appraisal of the policy to substantiate the gift on Form 8283.3

Nugget #2: If the policy has an outstanding loan at the time of gift, it may eliminate the entire deduction, because of a private benefit classification under the charitable reverse split-dollar legislation.4

2.  New Policy Donation—A simple process where the donor makes a dona- tion to a charity, which in turn, takes out a new policy on the donor’s

life. The charity, from the outset, is the owner and beneficiary. The donor may specify how she wishes the charity to use the proceeds. Regulations entitle the donor to an income tax deduction for the donation made to the charity. Note that under state law, an insurable interest must be present at the time the policy is issued. Some commentators have suggested that if a donor has never made a gift before, making an unrestricted contribution to the charity can help create an insurable interest prior to taking out the new policy.

Nugget #3: A tax-optimal way of making this donation would be with long-term appreciated property to get the full fair market deduction for the donation, and then to use the proceeds to fund the insurance.

Nugget #4: While administratively problematic, having the donor make the donation directly to the charity is the cleanest process. The charity can then make the premium payment. If the donor makes the premium payments directly, it may have the unintended consequence of reducing the deduction limitation to 20 percent of AGI, since it would be a gift “for the benefit of” rather than “to” the charity. Further, the audit trail is usually much easier to follow.

3.  Beneficiary Allocation—If the donor wishes to make a revocable gift, she can simply fill out a new beneficiary form with a specific allocation—per- centage or dollar amount—for the charity. An example, “I wish to desig- nate my husband, Chad Brown, for 95 percent of the benefit, and Charity ABC for 5 percent.” Of course, the donor may revoke the designation at any time, and therefore no income tax deduction would be available (though she may derive some estate tax benefits depending on how the policy was owned).

Nugget #5: This is the easiest, possible way of getting a charity’s board members into its Legacy Society. They can do this with an individual policy or even group term life from work. It takes very little time, and does not involve an attorney like a codicil. Additionally, through a percentage allocation, any socio-economic background can participate without eco- nomically harming heirs. For example, one percent of a $100,000 policy is

$1,000, but that might only represent 1/5th of 1 percent of the total estate. So there are really no excuses that a Board member could use to rationally exempt herself from participating—at least while on the Board.

4.  Wealth Replacement—The donor’s irrevocable life insurance trust (ILIT) typically owns the policy, rather than the charity. Nonetheless, this strategy may create a much larger gift than the donor originally imagined. It can also get a donor comfortable enough to even make the gift in the first place. Charities should be very comfortable with the structure and place- ment of wealth replacement, and how to integrate it into a charitable giving plan.

Nugget #6: For some reason, when charities hear “wealth replacement,” they immediately think of charitable remainder trust applications. This is like only using a back-hoe to build sand-boxes—an incredibly powerful and broad concept applied in a narrow space. The applications of wealth replacement are as powerful, if not more so, for straight bequests, gift annuities, major outright gifts, and, in particular, for qualified plans / IRA bequests. For example, with IRAs, a donor can take the minimum distribution, pay the tax, and then use the net to pay premiums on a life insurance policy. At death, the tax-disadvantaged retirement plan flows to charity, with no tax loss, and the insurance replaces the retirement balance for her heirs in a tax-advantaged way (assuming it was structured properly). During retirement, the donor would always have access to the full account if needed for lifestyle or emergencies. And from a planning perspective, wealth replacement does not always mean exactly the same value as the donation. It can be increased or decreased based on the donor’s wishes.

Nugget #7: Wealth replacement has also become an elegantly simple estate plan for some families. For many, estate planning is viewed as an expensive, complex and ever-changing process. And, this does not take into account the estate asset fluctuation over time. Some donors / clients have grown tired of the process and have devised a very straight-forward solution. Rather than always trying to follow estate planning rules, asset prices, vehicles, etc.—they simply say, “I want Johnny, Suzie and Timmy to get $2 million each. My wife and I will buy a survivorship life insurance policy for $6 million. Any assets we have not used during life will go to charity. Done.”This may not be optimal from a tax or estate planning per- spective, but some clients are choosing the certainty and simplicity over the uncertainty and complexity.

5.  Gift Annuity Reinsurance—This is an insurance policy (an immediate annuity) the charity purchases to match the contractual liability for one or a group of gift annuities. This kind of insurance can benefit the charity by shifting the longevity and investment risk to the insurance company. In this way, the charity may immediately release the difference creating a known amount at a known point in time, instead of a self-insured unknown amount at an unknown point in time. To be clear, the unknown amount may certainly be larger or smaller on a present value basis, depending on the mortality and investment experience of the gift annuity. This immediate surplus can be used for current pressing needs, or invested more aggressively in the endowment over time.

Nugget #8: Charities should follow IRC Section 170(f )(10) which exempt charity-owned annuities only to the extent that the contract matches the terms of the CGA contract in terms of the timing and amount of the liability. If this is not the case, the policy may not qualify under the law. Some recent, private letter rulings have ruled positively for a lifetime annuity with a premium refund, or for a period certain so long as the benefits and frequency match the gift annuity.5


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