Sponsored by DAFgiving360
By the Charitable Strategies Group at DAFgiving360™
When working with your clients to plan their charitable giving, it’s important to think about their entire financial landscape—and often, that might include life insurance policies.
If you have a philanthropically inclined client that no longer needs their life insurance policy, you may consider working with them to contribute their policy to a 501(c)(3) public charity, like a donor-advised fund. By contributing a life insurance policy during their lifetime, your client can use the value of their policy to benefit their favorite causes, while also claiming a current-year income tax deduction (if your client itemizes) and potentially reducing their estate tax liability. Your client can also name a charity now to be a beneficiary of their policy after their lifetime, helping to extend their charitable legacy.
What are the different ways a client can donate life insurance?
There are two primary methods to contribute life insurance to charity, and each one has different timing and tax benefits.
1. Have your client consult with their favorite charity about whether they can handle a life insurance donation. If they can, guide your client to transfer the policy ownership and beneficiary interest directly to charity, which is generally possible with permanent life insurance. After taking ownership, the charity may opt to surrender the policy for its cash value. (Life insurance companies often allow a policy owner to “surrender” their policy—in other words, cancel it to receive a cash value, minus any surrender charges and fees.)
Tax benefits for your client when employing this method:
- a. Life insurance is considered an ordinary income asset, meaning that surrendering a policy for its cash value would trigger ordinary income taxes for your client on the policy’s appreciation. But, by contributing their policy directly to charity, your client potentially avoids the tax they would otherwise incur if they surrendered the policy and donated the proceeds. And because U.S. public charities are tax-exempt, the charity can surrender the policy for its full, untaxed value, maximizing the impact of the contribution.
- b. Assuming your client itemizes their deductions when filing taxes, they may also claim a current-year tax deduction for the policy contribution. Because life insurance is an ordinary income asset, the deduction is limited to the lesser of the policy's value or your client’s adjusted cost basis in the policy (generally, premiums paid to date).
- c. An added benefit is that the policy’s value could potentially be removed from your client’s gross estate, lowering their estate’s eventual tax burden.
2. Work with your client so that they retain ownership of their policy but have them name a charity as a full or partial beneficiary on the policy. In this situation, the charity would receive a designated payout from the insurance company after your client’s lifetime. While your client wouldn’t be able to claim a charitable income tax deduction during their lifetime, their estate would be entitled to claim a charitable estate tax deduction for the beneficiary proceeds distributed to charity at their death.
This method can offer your client more flexibility in case their circumstances change (they can always change the beneficiary named on their policy), and it can be appealing to a client who might not otherwise be able to make a significant gift during their lifetime. Your client should keep in mind that they may need to continue paying policy premiums for the remainder of their life.
More advanced donation strategies exist, including options that replace income. If you’re interested in exploring those strategies for a client, we suggest working with a tax advisor or estate planning attorney.
What types of life insurance can be donated?
Clients can donate both permanent life insurance (including whole life and universal life) and term life insurance to charity, but the donation options differ.
Permanent life insurance policies hold cash value that can be surrendered. A cash value policy (in particular, a paid-in-full cash value policy) can be an appealing donation because clients have the option of gifting during their lifetimes, not just at the end of it. And by gifting during their lifetimes, clients may be able to take advantage of the tax benefits described above.
On the other hand, term life insurance donations have limitations. While term policies can still be used to benefit charity, gifting during one’s lifetime is not an option. Clients can only name a charity as an end-of-life beneficiary. And because term policies are only active for a specified period, you and an interested client should investigate whether the term policy could expire during the client’s lifetime.
Can a client donate life insurance to a donor-advised fund?
A donor-advised fund account, like the one offered by DAFgiving360™ is a simple, efficient, and tax-smart giving solution. By contributing to a donor-advised fund, clients can potentially reduce tax burdens, invest contributed assets for potential growth that’s tax-free, and recommend grants to qualified U.S. public charities immediately or over time. And by offering charitable planning for your clients, you can expand your role as a trusted advisor. DAFgiving360 offers advisors specialized support and a range of investment choices to give you and your clients the flexibility and guidance you need.
Donor-advised funds like DAFgiving360 are public charities themselves. Subject to prior due diligence review, DAFgiving360 can accept a client’s insurance policy as a charitable contribution and surrender it for a cash value. The funds are then made available for your client to recommend investments and grants.
Once you and your client have an account open, your client may also name their account as a beneficiary of their life insurance policy. Recommended grants to charities after your client’s lifetime would then be based on their account’s succession plan or granting history.
Maximizing a gift during a client’s lifetime
Let’s review a case study: Hypothetical donor Shannon has been working with her trusted financial advisor to find a way to make a charitable impact during her lifetime. Shannon’s advisor has a holistic understanding of Shannon’s assets and recognizes she may no longer need her permanent life insurance policy—she has accumulated more wealth than her family needs, even without the policy.
Shannon’s advisor explains to her that the value of her life insurance policy can be used as a charitable contribution. Alongside Shannon’s tax advisor, her advisor explores her policy surrender options and how she can maximize her charitable impact.
Option 1: Surrender policy for cash and then contribute the post-surrender proceeds.
Shannon’s policy has a $500,000 surrender cash value, with $200,000 in basis (premiums Shannon has paid over the years) and without a loan against it. Because life insurance is an ordinary income asset, if Shannon’s advisor guided her to surrender the policy for cash and then contribute the proceeds, she’d incur income tax on $300,000 (the policy gains). Assuming a 24% income tax rate, the post-surrender charitable contribution would be reduced from $500,000 to $428,000. (For simplicity, this hypothetical example assumes no surrender charge or other fees.)
Option 2: Contribute policy directly to charity, which then surrenders policy for its cash value.
If Shannon’s advisor worked with her to transfer the policy ownership to a desired charity and let the charity handle the surrender (rather than Shannon surrendering the policy for cash), Shannon would avoid any taxable income. And, as a tax-exempt entity, the charity would not pay income tax when surrendering the policy. Unlike the first option, the charity would receive the full $500,000 value. (Again, for simplicity, this hypothetical example assumes no surrender charge or other fees.)
(#912) This hypothetical example is only for illustrative purposes.
The example does not take into account any state or local taxes or potential surrender fees.
The tax savings shown is the tax deduction, multiplied by the donor’s marginal income tax rate (24% in this example), minus the income taxes paid. In option 2, the deduction is limited to the $200,000 policy basis.
Other considerations when donating a life insurance policy
1. Loans against the policy can complicate the charitable contribution. If your client has loans taken out against their insurance policy, they may be subject to IRS “bargain sale” rules, which can generate taxable income and lower the value of the charitable deduction.
2. Annual limits apply to charitable deductions. If your client itemizes deductions when filing taxes, their deduction for a during-life contribution of a cash value life insurance policy is generally limited to 50% of their adjusted gross income (AGI). Any deduction amount above this AGI limit may be carried forward for up to five additional tax years, subject to AGI limits in each year.
3. Qualified appraisal requirement rules may apply. To claim a charitable income tax deduction for during-life contributions of permanent life insurance policies, your client must not only itemize income tax deductions, but they also must obtain a qualified appraisal from a qualified appraiser if the claimed deduction is greater than $5,000. They also must file IRS Form 8283 with taxes for the tax year that the life insurance gift is made.
4. Donors may potentially minimize their gross estate’s tax exposure. Life insurance is included in one’s gross estate after their lifetime. By donating a policy during their lifetime, or by retaining their policy’s ownership and naming a charity as a policy beneficiary, your client can reduce the value of their gross estate, potentially minimizing eventual tax exposure.
5. Donors must work directly with their policy administrator to update ownership and/or beneficiary information. It can take time to finalize the policy ownership transfer through a policy administrator (insurance company), which could result in a delay to making the gift. If you and your client are planning to make this contribution near year-end, consider starting the process early to avoid any deadlines for yearly tax deduction eligibility. Please note that most charities want to know if a client plans to donate a life insurance policy, whether during or at the end of their lifetime. Some due diligence review prior to acceptance may also be required by the recipient charity.
Make an informed decision with our team of professionals
While it’s simple for you and your clients to use donor-advised fund accounts, life insurance and other non-cash assets can be nuanced. The Charitable Strategies Group at DAFgiving360 is an experienced team with specialized knowledge on contributing complex assets to charities. Our team can support you and your clients with unbiased guidance through each step of your contribution, from the initial consultation through processing the surrender of a policy.
If you’d like to learn more about working with DAFgiving360 and the benefits to both you and your clients, review our online resources or request more information.
Disclosures:
A donor's ability to claim itemized deductions is subject to a variety of limitations depending on the donor's specific tax situation.
Contributions of certain real estate, private equity, or other illiquid assets may be accepted via a charitable intermediary, with proceeds transferred to a donor-advised fund (DAF) account upon liquidation. Call DAFgiving360 for more information at 800-746-6216.
DAFgiving360™ is the name used for the combined programs and services of Donor Advised Charitable Giving, Inc., an independent nonprofit organization which has entered into service agreements with certain subsidiaries of The Charles Schwab Corporation. DAFgiving360 is a tax-exempt public charity as described in Sections 501(c)(3), 509(a)(1), and 170(b)(1)(A)(vi) of the Internal Revenue Code.
Contributions made to DAFgiving360 are considered an irrevocable gift and are not refundable. Once contributed, DAFgiving360 has exclusive legal control over the contributed assets.
DAFgiving360 does not provide legal or tax advice. Please consult a qualified legal or tax advisor where such advice is necessary or appropriate.
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