Life insurance in charitable planning
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A review of using life insurance in charitable planning taken from the book Visual Planned Giving (2014)
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Life insurance in charitable planning
- 1. Using Life Insurance in Charitable Planning
- 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. 1.Wealth replacement 2.Gifting existing policies 3.Creating new policies for the charity Common Uses
- 4. Using life insurance as wealth replacement in charitable planning Part I
- 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. But, they also reduce heirs’ inheritance Heir Charity Donor
- 7. Life insurance can diminish this concern
- 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. 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. 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. 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. 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. 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. We give the taxable inheritance to charity, and create income to purchase the non- taxable inheritance to give to children
- 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. 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. 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. 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. Donor can use tax deduction to buy tax free life insurance (ILIT) for children’s inheritance
- 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. Wealth replacement through ILIT life insurance creates estate tax free inheritance for family members and allows for charitable giving
- 22. Donor CRT Charity Initial Transfer Anything Left after Death of Donor and Kids Payments During Donor Life Donor kids Payments after Donor’s Death, During Kids Lives
- 23. Donor CRT Charity Initial Transfer Anything Left after Death of Donor and Kids Payments During Donor Life Donor kids Payments after Donor’s Death, During Kids Lives
- 24. Donor CRT Charity Initial Transfer Anything Left at Death Payments During Life
- 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. 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 Donor kids
- 27. Donor CRT Charity Initial Transfer Anything Left after Death of Donor and Kids Payments During Donor Life Donor kids Payments after Donor’s Death, During Kids Lives
- 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 Donor kids ILIT At donor death, pays annuity
- 29. Donor CRT Charity Initial Transfer Anything Left after Death of Donor and Kids Payments During Donor Life Donor kids ILIT At donor death, pays annuity
- 30. Donor CRT Charity Initial Transfer Anything Left after Death of Donor and Kids Payments During Donor Life Donor kids ILIT At donor death, pays annuity
- 31. Donor CRT Charity Initial Transfer Anything Left after Death of Donor and Kids Payments During Donor Life Donor kids ILIT At donor death, pays annuity
- 32. Donor CRT Charity Initial Transfer Anything Left after Death of Donor and Kids Payments During Donor Life Donor kids ILIT At donor death, pays annuity
- 33. Structure of the ILIT
- 34. Irrevocable Life Insurance Trust (ILIT) Parent Child Money to Pay Premiums Premium Payments Estate Tax Free Death Benefit Policy on Parent’s Life Insurance Inc. Donor cannot be ILIT trustee, otherwise in donor’s estate
- 35. Irrevocable Life Insurance Trust (ILIT) Parent Child Money to Pay Premiums Premium Payments Estate Tax Free Death Benefit Policy on Parent’s Life Insurance Inc. Gifts to the ILIT are taxable, thus can reduce the available credit for estate tax purposes
- 36. Irrevocable Life Insurance Trust (ILIT) Parent Child Money to Pay Premiums Premium Payments Estate Tax Free Death Benefit Policy on Parent’s Life Insurance Inc. Gifts to the ILIT are not “present interest” gifts, because recipients have to wait to receive benefit
- 37. Irrevocable Life Insurance Trust (ILIT) Parent Child Money to Pay Premiums Premium Payments Estate Tax Free Death Benefit Policy 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. Irrevocable Life Insurance Trust (ILIT) Parent Child Money to Pay Premiums Estate Tax Free Death Benefit Policy 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. Irrevocable Life Insurance Trust (ILIT) Parent Child Money to Pay Premiums Estate Tax Free Death Benefit Policy 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. 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. Irrevocable Life Insurance Trust (ILIT) Parent Child Money to Pay Premiums Estate Tax Free Death Benefit Policy 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. Irrevocable Life Insurance Trust (ILIT) Parent Child Money to Pay Premiums Estate Tax Free Death Benefit Policy 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. $224,000 per year can pay for a lot of estate tax free life insurance
- 44. Irrevocable Life Insurance Trust (ILIT) Parent Child Money to Pay Premiums Estate Tax Free Death Benefit Policy on Parent’s Life Insurance Inc. Premium Payments 30 day right to take gift as cash The “Crummey” power creates another problem
- 45. Irrevocable Life Insurance Trust (ILIT) Parent Child Money to Pay Premiums Estate Tax Free Death Benefit Policy 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. Irrevocable Life Insurance Trust (ILIT) Parent Child Money to Pay Premiums Estate Tax Free Death Benefit Policy 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. Irrevocable Life Insurance Trust (ILIT) Parent Child Money to Pay Premiums Estate Tax Free Death Benefit Policy 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. Irrevocable Life Insurance Trust (ILIT) Parent Child Money to Pay Premiums Estate Tax Free Death Benefit Policy 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. Irrevocable Life Insurance Trust (ILIT) Parent Money to Pay Premiums Premium Payments Estate Tax Free Death Benefit Policy 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. 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. Part II Giving existing life insurance policies to charity
- 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. 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. Typical policy gift valued at lower of these How do we calculate fair market value or donor’s basis?
- 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. 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. 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. Because of the “life settlement” market, policies may have value far beyond traditional calculations
- 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. Summary of qualified appraisal attached to tax return Note from charity before taxes filed or due (1)Date, location, and description of property (2)“No goods or services were provided in exchange for these gifts.” [or describe and value items provided] Donor’s reliable records of gift, charity, date, place, FMV (and cost basis if relevant)
- 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. 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. Don’t give life insurance with outstanding loans!
- 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. 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. Part III Creating new policies for the charity
- 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. Insurance Inc. Creation or Transfer of New Policy Gifts to be used for premiums Death Benefit to Charity •Standard gift receipt •Can give appreciated property •50% income limitation for cash 2014 2015 2016 2017 2018 … Death
- 78. Insurance Inc. Creation or Transfer of New Policy Premium Payments Death Benefit to Charity 2015 2016 2017 2018 … Death 2014 •Gift receipting depends on charity •Must give cash •30% income limitation for cash
- 79. Potential advantages and problems for charities and donors
- 80. Donor with small income can fund a large posthumous project Potential advantages
- 81. Donor receives a bill from the life insurance company instead of ongoing donation requests from charity Potential advantages
- 82. Insurance agents may help to “sell” the idea instead of requiring charity fundraiser time Potential advantages
- 83. Insurance agents may “oversell” risking long- term donor relationships Potential problems
- 84. Depending on policy structure, donor may give for years, and charity receives nothing due to later policy lapse Potential problems
- 85. Some policies may benefit insurance companies and agents more than charity Potential problems
- 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. The charity may prefer funds today Potential problems
- 88. The donor never sees the impact of the gift Potential problems
- 89. Donors cannibalize giving to pay premiums Regular giving to charity Premium Payments Potential problems
- 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. Otherwise, just say “No!” It isn’t “free” if the donors will be paying premiums instead of giving to your organization
- 92. 1.Wealth replacement 2.Gifting existing policies 3.Creating new policies for the charity Common Uses
- 93. Using Life Insurance in Charitable Planning
- 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. If you clicked on the link to let me know you reviewed these slides… Thank You!
- 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