Charitable giving with life insurance offers a way to leverage money for increased donations and minimize taxes.
It’s a less common strategy. There is an array of tax considerations, as well as strategies depending on your specific goals. We’ll cover them in detail.
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Donating to charity through life insurance is more complicated than setting up a recurring donation on your credit card. However, there are excellent tax benefits to yourself and your estate when set up correctly.
You have several options to choose from depending on your risk tolerance and charitable goals.
Current Charitable Giving Stats
Bequest donations account for 9% of all funds donated to non-profit organizations in the United States. This reached an all-time high of 35.7 billion dollars in 2018.
There are some interesting trends, and we’re waiting to see what behavior changes result from the estate tax law changes that happened in 2018. Analysts argue that the increase in non-taxable estate amounts will reduce charitable giving through less incentive to minimize one’s estate tax burden.
We’ll see how it plays out.
In the meantime, we do know that fewer Americans are donating to charity. However, the amount that Americans donate each year keeps increasing. In short, charitable funds come from fewer people donating more.
6 Ways to Donate Through Life Insurance
Some of these methods are simple. They provide tax benefits to you and limit the amount of chaos that can happen to an estate when heirs contest wills. It can also keep donations private since life insurance doesn’t need to pass through probate and avoids public records of the court system entirely.
Name a Charity as a Beneficiary on Your Existing Policy
This one is simple. It’s a great way to ensure that some of your life insurance benefits go to charity immediately. The distribution cannot be contested because life insurance is a legally binding contract.
Life insurance policies give you the option to name multiple beneficiaries. You can also allocate a percentage of benefits to each beneficiary. The portions don’t need to be equal. For example, someone might set it up in the following way:
- 50% to spouse
- 25% split equally between children
- 25% to a charity
You could even split it into multiple charities if you wanted. How you allocate your life insurance benefits is up to you as the policy owner.
Charitable Giving Riders
Some insurance companies allow you to add a charitable giving rider. Most often, this rider doesn’t increase the policy premiums at all.
The insurance company automatically donates to the charity name on your behalf an amount equivalent to 1% (sometimes 2%) of the death benefit when someone submits the claim.
You chose the charity at the time of the application, but you can change it later.
The advantages here are donations are automatic, don’t cost you anything, and don’t reduce the amount going to your heirs.
Gift Policy Dividends
This one is fun and easy. Although, there is a big pitfall to watch out for.
The first method involves requesting the policy dividends in cash and then donating that amount each year. It’s money that barely touches your bank account, so it doesn’t feel like a loss. However, it requires some work on your part.
The second method uses the dividends to pay for a second life insurance policy. The difference is that the charity will own this second policy, and the dividends from your first policy pay the premiums on it.
The pitfall to watch here is that policy dividends often go toward things like the cash value or can prevent a policy from lapsing if you suffer a financial tragedy.
Transfer Ownership of the Policy to a Charity
This method offers advantages to every party involved. The charity gets to decide how to best use the policy for their current needs. They may cash it out immediately, hold on to it for a larger donation later, or even take advantage of the policy’s cash value while keeping it in force.
As the former owner, you get to dispose of a life insurance policy that you no longer need in a way where everyone benefits.
When you donate the policy to a charity, you get a tax deduction. Rather than cashing it out for a surrender value, there can often be a financial advantage to minimizing your tax burden instead.
Depending on the charity’s preference, they may take over premium payments, or you might continue paying the premiums. If you continue to pay premiums, the IRS considers each premium payment as a charitable donation.
Charitable Trust Beneficiary/Charitable Remainder Trust
Charitable remainder trusts typically work in conjunction with wealth replacement trusts, but they can work by themselves. It all depends on your goals. Most people choose one of two types:
- Charitable remainder annuity trust
- Charitable remainder unitrust
In a charitable remainder trust, you donate assets to the irrevocable trust. It can sell assets without capital gains tax, meaning bigger gains to reinvest. The trust then pays you distributions for the rest of your life using the profits made in managing the assets you transferred.
In short, it both gives you an income stream during your lifetime, and then, when you pass on, the entirety of the trust goes to the named charity.
Wealth Replacement Trust
Most people choose to combine their charitable remainder trust with a wealth replacement trust. With the charitable remainder trust, all of the assets go to charity and not the family when you pass away.
The wealth replacement trust offers an estate tax way to make sure that life insurance can benefit your family as well.
Insurance agents create wealth replacement trusts as irrevocable life insurance trusts. The trust will buy life insurance on you. You make donations to the trust every year that it will use to pay for the life insurance premiums.
The trust is also the policy beneficiary in addition to the owner. This way, the benefits never touch your estate and can be passed on privately to your heirs, spouse, charity, or whomever.
Tax Implications on Donating with Life Insurance
When you’re donating to charity using your life insurance, you absolutely need to get a tax expert involved. There are all sorts of special rules you need to follow for the IRS to be happy. This section covers the basics of the tax implications, but each method of charitable contribution has its tax quirks. Talk to an accountant with experience in this area.
When donating a policy to charity, you’re able to claim a tax deduction for the policy’s value up to 50% of your adjusted gross income. You also get to deduct the cash you donate to that charity each year thereafter to pay for the policy premiums.
Qualified Appraisal of Gift
One major complaint from accountants on charitable donations of life insurance is oftentimes donors and charities don’t go through the appraisal process and get surprised when the tax deductions are not what they initially thought.
First, deductions are limited to the lesser of the death benefit or the policy’s fair market value. The death benefit is straightforward. The fair market value of the policy is typically the cash value or surrender value.
Before we dive into that, any policy over $5,000 needs a “qualified appraisal of gift” for the IRS to believe you. The donor pays for this appraisal, ideally before the donation. That way, both the donor and the charity know what they’re getting and how that affects their assets, cash flow, and tax burden.
Pros & Cons of Donating Life Insurance
The vast range in life insurance policies means that pros and cons will vary depending on your strategy. A financial advisor can be a valuable asset in figuring out these strategies and tax implications.
First, you can reduce your estate value. One of the most effective methods employed is an irrevocable life insurance trust. The money will still go to your heirs but won’t technically be part of your estate.
Second, you can make a larger donation than might have otherwise made sense. A life insurance policy where you pay less in premiums than will pay out in death benefits gives both you and the charity an advantage.
Third, families argue over money. It’s a bummer but common. Heirs dispute charitable donations. The estate executor may use the funds marked for a charitable donation to pay the estate taxes instead, thereby increasing the estate’s heirs’ share. It gets legally messy. Since life insurance is a contract, that money skips the whole legal side and goes straight to charity.
Some non-profits don’t have the resources to handle life insurance contracts, even if the donor continues to pay the premiums. They need people on staff who understand life insurance and how to manage it.
Before choosing a charity to donate to, look into how they treat life insurance. Many will automatically cash out the policy instead of maintaining it, so they don’t have to deal with the administration.
The second drawback, and arguably the larger one, is these strategies get complicated. When donating cash to charity, it’s easy. They make it easy on purpose. Life insurance, between policy ownership, insurable interest, and tax implications, either needs someone who loves understanding finances or help from a finance professional.
Are premiums tax deductible if the beneficiary is a charity?
The charity also needs to be the policy owner to deduct the premiums on your income tax. You would donate your policy to a charity. The charity becomes owner and beneficiary, and you remain the payor. For estate taxes, the death benefits going to charity are deductible.
Can I deduct past premiums from my taxes if I gift an existing policy to a charity?
Unfortunately, no. You can deduct the lower of the fair market value or the death benefit on the policy. Any policy gifted over $5,000 requires a qualified appraisal of gift to avoid contention with the IRS over the value and amount you can deduct.
How do I make my charity a beneficiary?
You can change beneficiaries on a policy at any time. All you have to do to allocate some or all of your life insurance benefits to a charity is name them as a beneficiary. You can also divide the benefits between different beneficiaries in any way you’d like.
Donating life insurance is more complicated than dropping off unneeded clothing at your nearest charitable center. Still, it also provides several ways to leverage donations to charity and donate more than you pay in.
You have many options to assess. But examining each method of donating life insurance to charity means more ways to benefit both the charity and minimize your tax burden.
How Abrams Insurance Solutions Can Help
We’re a small group of independent agents and financial planners looking to help clients build a strong financial foundation so they can enjoy their lives without worry. While life insurance is just one of those pillars, we also realize that situations change, and policies aren’t always needed later in life.
If you want to explore options on whether you’ll get more value from donating your life insurance to charity or simply surrendering it, give us a call, and we will be happy to help assess your options.
Give us a call today at 858-703-6178. We will answer any questions, and there is never any obligation to move forward.