Over 72% of all contributions to charitable organizations in 2016 were made by individuals, according to the Giving USA Foundation. People give to charities for a variety of reasons. These reasons include:
- A compassion for the less fortunate
- A belief that they owe something back to society
- A wish to support a favored institution or cause
- The recognition attained by making substantial charitable donations
- The benefit received from the financial incentives the U.S. tax system provides for charitable gifts
Regardless of the reasons for giving, a gift of life insurance can represent a substantial future gift to a favorite charity at relatively little cost to the donor.
How Life Insurance Is Given to a Charity
There are several ways a life insurance policy can be given to a charity:
- Make a charity the beneficiary of an existing policy
- Make a charity the owner and beneficiary of an existing policy
- Help a charity purchase a new insurance policy on an estate owner’s life
Most states allow a charity to be the owner and/or beneficiary of an insurance policy on a donor’s life through “insurable interest” laws.
Making a Charity the Beneficiary of an Existing Policy
If a person has a life insurance policy they no longer need, they can name the charity as the beneficiary of the policy. After the person dies, the charity will receive the policy’s death benefits. There are no tax benefits to this approach for the person. However, the value of the policy is not included when federal estate taxes are determined.
Making a Charity the Owner and Beneficiary of an Existing Policy
A second option is instead of simply naming the charity on the existing life insurance policy, ownership of the entire policy is transferred to the charity. Then, when the person dies, the charity receives the death benefits. In addition, the value of the life insurance policy is removed from the estate when federal estate taxes are determined. The final bonus is that this type of approach provides a person with current federal income tax deductions.
Helping a Charity Purchase a New Insurance Policy
A final option involves purchasing a life insurance policy that names the charity as both the beneficiary and owner. Then, make arrangements to pay the premiums through gifts to the charity. This allows federal income tax deductions to be taken and the elimination of the policy proceeds when determining federal estate taxes.
Since state laws vary, it is extremely important to consult with a highly qualified financial advisor or attorney before making a gift of this kind.
Federal Income Tax Deductions
Gifts to a charity are deductible up to half of the donor’s adjusted gross income (AGI). However, the charity must be a qualified public charity in order to receive this type of deduction. If the monetary value of the gift exceeds this limit, the excess can be carried over for up to five consecutive years. The donor must also itemize their taxes in order to be able to claim a charitable income tax deduction. For taxpayers with AGIs above a particular amount, a portion of the itemized deductions are phased out.
How the Charitable Deductions Work
Depending on the type of life insurance gift given, the charitable income tax deductions are treated differently. For example:
- If a charity is named as only the beneficiary of an existing life insurance policy, then no charitable income tax deductions can be taken.
- If a charity is named as owner and beneficiary of an existing life insurance policy, then deductions can be taken two ways. The lesser of either the cost basis in the policy or the value of the policy at the time it was transferred to the charity can be taken.
- If a charity is named as owner and beneficiary of a new life insurance policy, then annual cash gifts are given to the charity which, in turn, uses it to purchase an insurance policy on the donor’s life. Each cash gift is eligible for a deduction the year it was made.
In any of the above cases, in each year a charitable gift is made, a receipt from the charity should show the donor’s name, date, and description of the life insurance policy.
Federal and State Gift and Estate Tax Benefits
For life insurance charitable gifts, there are federal gift tax laws and federal estate tax deduction laws.
- Federal Gift Tax – Irrevocable or Irreversible gifts to a charity are not subject to federal gift taxation. Simply put, an existing life insurance policy or any future gift given to a charity to pay the premiums of a life insurance policy on the donor are not subject to any federal gift taxes.
- Federal Estate Tax Deduction with the Charity as the Owner and Beneficiary – If a charity is both owner and beneficiary of a life insurance policy on a donor, the policy proceeds will pass directly to the chosen charity at the donor’s death. Therefore, the proceeds from the life insurance policy go directly to the charity and are not included in determining any federal estate taxes.
- Federal Estate Tax Deduction with the Donor as the Owner and the Charity as the Beneficiary – If a donor chooses to keep the policy and name the charity as beneficiary, then at the donor’s death the value of the policy proceeds is included in the overall value of the estate. However, a federal estate tax deduction for charitable gifts is allowed at an estate owners death. In addition, there is not a limit to the size of the federal estate tax charitable deduction for this type of gift.
For state deductions on charitable gifts of life insurance, it is advised to consult with a professional tax advisor or financial planner to prevent any tax consequences.
With almost 3 out of 4 donations made in 2016 coming from individuals, finding the best way give more money to charities and less money to the government is demanded by most. Planning now will allow you to put your money to the best use possible: charitable giving.