Using Life Insurance in Charitable Planning

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These slides are taken from the graduate financial planning course "Introduction to Charitable Planning" at Texas Tech University. Details at www.EncourageGenerosity.com

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Using Life Insurance in Charitable Planning

  1. 1. Using Life Insurance in Charitable Planning
  2. 2. All slides are taken from this book which includes detailed explanations of all concepts. Available from Amazon.com Full color version available at www.createspace.com/4707238
  3. 3. 1.Wealth replacement 2.Gifting existing policies 3.Creating new policies for the charity Common Uses
  4. 4. Using life insurance as wealth replacement in charitable planning Part I
  5. 5. Charitable planning devices such as Charitable Gift Annuities, Gifts of Remainder Interests in Homes and Farms, and Charitable Remainder Trusts produce amazing tax advantages, reducing income taxes, capital gain taxes, and estate taxes
  6. 6. But, they also reduce heirs’ inheritance Heir Charity Donor
  7. 7. Life insurance can diminish this concern
  8. 8. 1. Anything you own is taxable at death unless it goes to a spouse or charity 2. If your life insurance is owned by another person or an Irrevocable Life Insurance Trust (ILIT) it is not taxable at your death (unless policy given in prior 3 years) Estate tax law made simple
  9. 9. Parent Money to Pay Premiums Insurance Inc. Because the parent does not own the policy, it is not taxed in his estate Child Policy on Parent’s Life Premium Payments Estate Tax Free Death Benefit
  10. 10. Irrevocable Life Insurance Trust (ILIT)Parent Child Money to Pay Premiums Policy on Parent’s Life Because the parent does not own the policy, it is not taxed in his estate Insurance Inc. Premium Payments Estate Tax Free Death Benefit
  11. 11. Irrevocable Life Insurance Trust (ILIT)Parent Child Money to Pay Premiums Policy on Parent’s Life Insurance Inc. The parent can use the tax benefit or income from a CGA or CRT to pay for life insurance Premium Payments Estate Tax Free Death Benefit
  12. 12. Irrevocable Life Insurance Trust (ILIT)Parent Child Money to Pay Premiums Policy on Parent’s Life Insurance Inc. Charitable Remainder Trust (CRT) Premium Payments Estate Tax Free Death Benefit Tax Deduction + Ongoing Income
  13. 13. Irrevocable Life Insurance Trust (ILIT)Parent Child Money to Pay Premiums Policy on Parent’s Life Insurance Inc. The child gets a tax free inheritance instead of losing up to 40% in estate taxes Premium Payments Estate Tax Free Death Benefit
  14. 14. We give the taxable inheritance to charity, and create income to purchase the non- taxable inheritance to give to children
  15. 15. Irrevocable Life Insurance Trust (ILIT)Parent Child Money to Pay Premiums Policy on Parent’s Life Insurance Inc. Premium Payments Gifts for premiums can be gift tax free if ≤ $14,000 X beneficiaries X donors annually. (E.g., 2 parents to 2 children, spouses, and 4 grandchildren: 2 X 8 X $14,000 = $224,000) Estate Tax Free Death Benefit
  16. 16. Can it pay to be charitable? Priscilla wants to sell a $1,000,000 non-income producing zero-basis asset then spend the interest income of 5% while leaving principal for heirs. Her tax rates are: capital gains (23.8%) income (39.6%) estate (40%)
  17. 17. Sale $1,000,000 asset -$238,000 capital gains tax Client uses $38,100/year ($762,000 X 5% return) Heirs receive $457,000 ($762,000-$304,800 est. tax) CRUT $1,000,000 asset $0 capital gains tax $1,000,000 in 5% unitrust pays $50,000 annually + a charitable tax deduction of $300,000 worth $118,000 + ILIT Client pays $118,000 initially and $11,900 annually for a $457,000 ILIT-owned policy Client uses $38,100/year Charity receives $1,000,000 remainder Heirs receive $457,000 (tax free from ILIT)
  18. 18. John, age 59, at 39.6% income tax rate, owns $100,000 of farmland which he would like to use for the rest of his life then leave to charity, but he also wants to benefit his heirs
  19. 19. Donor can use tax deduction to buy tax free life insurance (ILIT) for children’s inheritance
  20. 20. Giving the remainder interest to charity creates a deduction of $80,479 worth $32,869. Suppose this will purchase a paid-up policy of about $50,000+. (Using 1% AFR, however policy costs and deduction size offset as interest rates change) John keeps lifetime use of farm Charity gets 100% of farm at death Heirs get $50,000+ (estate tax free)
  21. 21. Wealth replacement through ILIT life insurance creates estate tax free inheritance for family members and allows for charitable giving
  22. 22. Donor CRT Charity Initial Transfer Anything Left after Death of Donor and Kids Payments During Donor Life Donorkids Payments after Donor’s Death, During Kids Lives
  23. 23. Donor CRT Charity Initial Transfer Anything Left after Death of Donor and Kids Payments During Donor Life Donorkids Payments after Donor’s Death, During Kids Lives
  24. 24. Donor CRT Charity Initial Transfer Anything Left at Death Payments During Life
  25. 25. Donor CRT Charity Initial Transfer Anything Left after Death of Donor and Spouse Payments During Donor Life Donor’s spouse Payments after Donor’s Death for Spouse’s Life
  26. 26. Donor CRT Charity Initial Transfer Anything Left after Death of Donor and Kids Payments During Donor Life Payments after Donor’s Death for Kid’s Lives Donorkids
  27. 27. Donor CRT Charity Initial Transfer Anything Left after Death of Donor and Kids Payments During Donor Life Donorkids Payments after Donor’s Death, During Kids Lives
  28. 28. Payments after Donor’s Death, During Kids Lives Donor CRT Charity Initial Transfer Anything Left after Death of Donor and Kids Payments During Donor Life DonorkidsILIT At donor death, pays annuity
  29. 29. Donor CRT Charity Initial Transfer Anything Left after Death of Donor and Kids Payments During Donor Life DonorkidsILIT At donor death, pays annuity
  30. 30. Donor CRT Charity Initial Transfer Anything Left after Death of Donor and Kids Payments During Donor Life DonorkidsILIT At donor death, pays annuity
  31. 31. Donor CRT Charity Initial Transfer Anything Left after Death of Donor and Kids Payments During Donor Life DonorkidsILIT At donor death, pays annuity
  32. 32. Donor CRT Charity Initial Transfer Anything Left after Death of Donor and Kids Payments During Donor Life DonorkidsILIT At donor death, pays annuity
  33. 33. Structure of the ILIT
  34. 34. Irrevocable Life Insurance Trust (ILIT)Parent Child Money to Pay Premiums Premium Payments Estate Tax Free Death BenefitPolicy on Parent’s Life Insurance Inc. Donor cannot be ILIT trustee, otherwise in donor’s estate
  35. 35. Irrevocable Life Insurance Trust (ILIT)Parent Child Money to Pay Premiums Premium Payments Estate Tax Free Death BenefitPolicy on Parent’s Life Insurance Inc. Gifts to the ILIT are taxable, thus can reduce the available credit for estate tax purposes
  36. 36. Irrevocable Life Insurance Trust (ILIT)Parent Child Money to Pay Premiums Premium Payments Estate Tax Free Death BenefitPolicy on Parent’s Life Insurance Inc. Gifts to the ILIT are not “present interest” gifts, because recipients have to wait to receive benefit
  37. 37. Irrevocable Life Insurance Trust (ILIT)Parent Child Money to Pay Premiums Premium Payments Estate Tax Free Death BenefitPolicy on Parent’s Life Insurance Inc. We turn the gifts into “present interest” gifts by giving beneficiaries the temporary right to get the gift in cash
  38. 38. Irrevocable Life Insurance Trust (ILIT) Parent Child Money to Pay Premiums Estate Tax Free Death BenefitPolicy on Parent’s Life Insurance Inc. Premium Payments 30 day right to take gift as cash We turn the gifts into “present interest” gifts by giving beneficiaries the temporary right to get the gift in cash
  39. 39. Irrevocable Life Insurance Trust (ILIT) Parent Child Money to Pay Premiums Estate Tax Free Death BenefitPolicy on Parent’s Life Insurance Inc. Premium Payments 30 day right to take gift as cash This temporary right to get the gift in cash is called a “Crummey” power
  40. 40. Of course, we explain to the beneficiary it is best not to take the cash and destroy the planning I don’t feel like using my “Crummey” power to take the cash immediately
  41. 41. Irrevocable Life Insurance Trust (ILIT) Parent Child Money to Pay Premiums Estate Tax Free Death BenefitPolicy on Parent’s Life Insurance Inc. Premium Payments 30 day right to take gift as cash Gifts for premiums can be gift tax free if ≤ $14,000 X beneficiaries X donors annually
  42. 42. Irrevocable Life Insurance Trust (ILIT) Parent Child Money to Pay Premiums Estate Tax Free Death BenefitPolicy on Parent’s Life Insurance Inc. Premium Payments 30 day right to take gift as cash 2 parents to 2 children, spouses, and 4 grandchildren 2 X 8 X $14,000 = $224,000 per year using “Crummey” powers
  43. 43. $224,000 per year can pay for a lot of estate tax free life insurance
  44. 44. Irrevocable Life Insurance Trust (ILIT) Parent Child Money to Pay Premiums Estate Tax Free Death BenefitPolicy on Parent’s Life Insurance Inc. Premium Payments 30 day right to take gift as cash The “Crummey” power creates another problem
  45. 45. Irrevocable Life Insurance Trust (ILIT) Parent Child Money to Pay Premiums Estate Tax Free Death BenefitPolicy on Parent’s Life Insurance Inc. Premium Payments 30 day right to take gift as cash When the beneficiary chooses not to take the cash, he makes a gift to the other trust beneficiaries
  46. 46. Irrevocable Life Insurance Trust (ILIT) Parent Child Money to Pay Premiums Estate Tax Free Death BenefitPolicy on Parent’s Life Insurance Inc. Premium Payments 30 day right to take gift as cash This gift is not a “present interest” gift, and will reduce the beneficiary’s available estate tax credit
  47. 47. Irrevocable Life Insurance Trust (ILIT) Parent Child Money to Pay Premiums Estate Tax Free Death BenefitPolicy on Parent’s Life Insurance Inc. Premium Payments 30 day right to take gift as cash But, beneficiary can release greater of $5,000 or 5% of trust amount tax free
  48. 48. Irrevocable Life Insurance Trust (ILIT) Parent Child Money to Pay Premiums Estate Tax Free Death BenefitPolicy on Parent’s Life Insurance Inc. Premium Payments 30 day right to take gift as cash One solution: beneficiary retains right to demand cash, except for $5,000/5% annual release (a.k.a. “hanging power”)
  49. 49. Irrevocable Life Insurance Trust (ILIT)Parent Money to Pay Premiums Premium Payments Estate Tax Free Death BenefitPolicy on Parent’s Life Insurance Inc. Grandchildren Not generation skipping transfer tax free unless separate ILIT for each grandchild (included in each grandchild’s estate)
  50. 50. ILIT-CRT planning creates flexibility CRT reduces inheritance Use part of CRT payments or tax deduction for ILIT CRT can pay to children but creates estate taxes Remove children CRT beneficiaries, increase CRT payments to pay for tax free ILIT owned life insurance for children
  51. 51. Part II Giving existing life insurance policies to charity
  52. 52. •Bought too much insurance for actual or current needs •Bought for children who are no longer dependent •Bought for an outdated business buy-sell agreement •Doesn’t need the cash value
  53. 53. Giving a life insurance policy means giving all rights to the charity • No incidents of ownership • No ability to borrow or change beneficiaries • No indirect benefit to donor
  54. 54. Typical policy gift valued at lower of these How do we calculate fair market value or donor’s basis?
  55. 55. Uncertainty in Basis Valuation For payments from insurance company Basis = + premiums paid – refunds – loans For sales to others Basis = + premiums paid – refunds – loans –“Cost of insurance” (term portion of policy) Uncertain for charitable gifts Will “cost of insurance” reduction fail in court review? Will it apply to gifts?
  56. 56. For universal life policies, “Cost of Insurance” is reported to the policyholder. For traditional whole life policies, “Cost of Insurance” may not be reported or easily determined. For term insurance, “Cost of Insurance” is the premium.
  57. 57. Typical fair market value Premiums due policy: ≈ cash surrender value, greater of ITR (n/a variable or universal life) + or PERC Newly issued policy: use first premium paid for fair market value Paid-up policy: replacement policy for insured of that age
  58. 58. Because of the “life settlement” market, policies may have value far beyond traditional calculations
  59. 59. Life settlement value above cash surrender value is probably deductible as long-term capital gain Life settlement value up to cash surrender value is ordinary income and deductible only at basis $150,000 life settlement value $50,000 cash surrender value $20,000 basis Deduction would likely be $20,000 + $100,000
  60. 60. Summary of qualified appraisal attached to tax return Notefromcharitybeforetaxes filedordue (1) Date,location,and descriptionofproperty (2) “Nogoodsorserviceswere providedinexchangefor thesegifts.”[ordescribe andvalueitemsprovided] Donor’s reliable recordsofgift,charity, date,place,FMV(and costbasisifrelevant)
  61. 61. Neither the insurance agent who sold the policy nor the insurance company may prepare the appraisal because they are parties to the transaction
  62. 62. Donating a policy with outstanding loans is bad planning! • Under charitable split-dollar rules the deduction (for gift or future premiums) will be entirely lost • Donor is taxed on ordinary income in the amount of loan less the applicable basis, which is loan amount X (policy basis/policy FMV)
  63. 63. Don’t give life insurance with outstanding loans!
  64. 64. After getting a policy the charity may • Ask donor to continue to pay premiums • Surrender for cash value • Pay premiums from charity’s funds • Sell in the life settlement market
  65. 65. Annuity contracts may be poor gifts • Donor will immediately recognize all gain in contract as ordinary income • If issued pre-1/23/87 and not matured deduction limited to cost basis • Gifting at death is not a problem
  66. 66. Part III Creating new policies for the charity
  67. 67. Insurance Inc. Creation or Transfer of New Policy 2014 Gifts to be used for premiums Death Benefit to Charity Option 1: Donor makes gifts to be used as premium payments Gifts are deductible if donor keeps no rights in the policy 2015 2016 2017 2018 … Death
  68. 68. Insurance Inc. Creation or Transfer of New Policy Premium Payments Death Benefit to Charity Option 2: Donor pays premiums on charity- owned policy Gifts are deductible if donor keeps no rights in the policy 2014 2015 2016 2017 2018 … Death
  69. 69. Insurance Inc. Creation or Transfer of New Policy Gifts to be used for premiums Death Benefit to Charity 1. Deductible so long as donor retains no rights in the policy 2014 2015 2016 2017 2018 … Death
  70. 70. Insurance Inc. Creation or Transfer of New Policy Premium Payments Death Benefit to Charity 2. Deductible so long as donor retains no rights in the policy 2014 2015 2016 2017 2018 … Death
  71. 71. Insurance Inc. Creation or Transfer of New Policy Gifts to be used for premiums Death Benefit to Charity 1. Standard gift receipt 2014 2015 2016 2017 2018 … Death
  72. 72. Insurance Inc. Creation or Transfer of New Policy Premium Payments Death Benefit to Charity 2. Gift receipting practice depends on charity 2014 2015 2016 2017 2018 … Death
  73. 73. Insurance Inc. Creation or Transfer of New Policy Gifts to be used for premiums Death Benefit to Charity 1. Donor can give appreciated property 2014 2015 2016 2017 2018 … Death
  74. 74. Insurance Inc. Creation or Transfer of New Policy Premium Payments Death Benefit to Charity 2. Donor must give cash 2014 2015 2016 2017 2018 … Death
  75. 75. Insurance Inc. Creation or Transfer of New Policy Gifts to be used for premiums Death Benefit to Charity 1. Income limitation of 50% for cash gifts 2014 2015 2016 2017 2018 … Death
  76. 76. Insurance Inc. Creation or Transfer of New Policy Premium Payments Death Benefit to Charity 2. Income limitation of 30% “for the use of” charity 2015 2016 2017 2018 … Death 2014
  77. 77. Insurance Inc. Creation or Transfer of New Policy Gifts to be used for premiums Death Benefit to Charity • Standard giftreceipt • Cangiveappreciated property • 50%incomelimitation forcash 2014 2015 2016 2017 2018 … Death
  78. 78. Insurance Inc. Creation or Transfer of New Policy Premium Payments Death Benefit to Charity 2015 2016 2017 2018 … Death 2014 • Giftreceipting depends oncharity • Must givecash • 30%incomelimitation forcash
  79. 79. Potential advantages and problems for charities and donors
  80. 80. Donor with small income can fund a large posthumous project Potential advantages
  81. 81. Donor receives a bill from the life insurance company instead of ongoing donation requests from charity Potential advantages
  82. 82. Insurance agents may help to “sell” the idea instead of requiring charity fundraiser time Potential advantages
  83. 83. Insurance agents may “oversell” risking long- term donor relationships Potential problems
  84. 84. Depending on policy structure, donor may give for years, and charity receives nothing due to later policy lapse Potential problems
  85. 85. Some policies may benefit insurance companies and agents more than charity Potential problems
  86. 86. Potential problems: Insurable interest (i.e., you can’t take out a life insurance policy on a stranger) Has now mostly been fixed by legislation
  87. 87. The charity may prefer funds today Potential problems
  88. 88. The donor never sees the impact of the gift Potential problems
  89. 89. Donors cannibalize giving to pay premiums Regular giving to charity Premium Payments Potential problems
  90. 90. A charity can prevent problems by refusing to accept policy gifts that don’t meet its guidelines. Assume cannibalization of gift income and require • Short-term (e.g., 10 year) to projected paid up status to age 100 • Top companies • Reasonable interest rate projections
  91. 91. Otherwise, just say “No!” It isn’t “free” if the donors will be paying premiums instead of giving to your organization
  92. 92. 1.Wealth replacement 2.Gifting existing policies 3.Creating new policies for the charity Common Uses
  93. 93. Using Life Insurance in Charitable Planning
  94. 94. Help me HERE convince my bosses that continuing to build and post these slide sets is not a waste of time. If you work for a nonprofit or advise donors and you reviewed these slides, please let me know by clicking
  95. 95. If you clicked on the link to let me know you reviewed these slides… Thank You!
  96. 96. This slide set is from the curriculum for the Graduate Certificate in Charitable Financial Planning at Texas Tech University, home to the nation’s largest graduate program in personal financial planning. To find out more about the online Graduate Certificate in Charitable Financial Planning go to www.EncourageGenerosity.com To find out more about the M.S. or Ph.D. in personal financial planning at Texas Tech University, go to www.depts.ttu.edu/pfp/ Graduate Studies in Charitable Financial Planning at Texas Tech University

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