Once again, right upfront here I’d like to thank Rodney Smith over at Helping Hands for Freedom for helping put this 2-part blog together. You can learn more about Rodney and his work with helping military families of the fallen, wounded and deployed by clicking the link.
Gifting Life Insurance Policies – Why It Makes Sense (Part 2)
Last week I provided a general overview and then discussed the first option for gifting life insurance – Purchasing a New Policy. In this week’s conclusion, I’ll review the other two options: Donation of an old insurance policy, and the Purchase of Wealth Replacement Insurance. Let’s get to it!
2. Donation of an old insurance policy. Donors who have old policies once acquired for other reasons (e.g., mortgage or debt risks, education for children, survivor income security or veterans’ policies) may no longer need the coverage and choose to transfer ownership to a nonprofit. If the donor transfers the ownership of the policy to a nonprofit organization, then besides removing the asset from the donor’s estate, it will often generate an income tax deduction equal to the lesser of cost basis or fair market value of the policy, if all of the rights of ownership are completely transferred.
The valuation of the policy is an oft-unrecognized problem for an asset potentially worth more than $5,000. Some would argue that the insurance carrier can easily assess and report its value on an IRS form 712, but the agent and insurance carrier, as parties to the transaction, cannot perform the valuation, and thus an outside appraiser is required.
The fair market value of the policy is a function of the policy type at hand. Occasionally donors will have old life insurance policies with loans against the cash value. Donating such a policy, however, will not provide your client with a charitable income tax charitable deduction, something else to consider.
3. Purchase of wealth replacement insurance. Another use of life insurance in an estate plan is to offset the gift of an asset by replacing the wealth, so heirs aren’t unduly affected. These so-called “wealth replacement” plans are very popular when working with large bequests, charitable remainder trusts or gift annuities. It leaves the heirs their inheritance while still realizing the client’s dream of supporting his or her favorite organizations. Why shouldn’t the heirs simply inherit those assets and skip the insurance policy hassle? It might be more tax efficient to leave heirs an asset that always steps up in value at death. In contrast, commercial annuities or retirement plan proceeds come with an accompanying income tax and artificially inflate the taxable estate of the deceased donor. If the life insurance is properly structured and held outside of the estate (typically in an irrevocable life insurance trust with Crummey provisions or owned by a single heir), then the proceeds pass to heirs without income, gift or estate tax liabilities.
So in conclusion, how can you approach potential donors concerning charitable donations of an insurance policy? Well, begin by finding out which policies are in place, and don’t forget group plans provided by an employer. Review the ownership and beneficiary designations of any policy. Oftentimes clients discover ex-spouses or deceased beneficiaries are still listed, so it’s a great opportunity to suggest changes and introduce a charitable gift into the equation. If donors will consider naming a charitable organization for a portion of the death benefit, they may also consider transferring the ownership of the entire policy by absolutely assigning it and receiving tax benefits in the process. But, as always, you won’t know unless you ask, and because few donors realize that they can split beneficiary designations, they often don’t consider it.
