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Charitable Planning Using Life Insurance

Charitable Planning Using Life Insurance

June 20, 2022

Renowned artist Pablo Picasso said, “The meaning of life is to find your gift. The purpose of life is to give it away.”  Giving to your community can provide many benefits and opportunities, both to the charitable organization and to the donor.  A charity benefits from donations that can further its mission, while the donor potentially receives tax benefits and gains satisfaction from pursuing philanthropic goals.  

At Cedar Point Financial Services LLC, we not only assist both individual clients in fulfilling their goals of charitable giving, but we also support charitable organizations with their fundraising efforts.   The ways in which donations involving life insurance can be made to charity vary and can be customized to achieve specific planning objectives.

Several benefits to a donor may be gained from the use of life insurance to satisfy charitable planning goals:

  • Possibility of a charitable income tax deduction
  • Potential gift tax savings and/or reduction in estate tax owed
  • Possible retention of an income stream from a transferred policy for life or a period of years
  • Possible avoidance of capital gains tax on a highly appreciated asset
  • Potentially replacing an asset given to charity with life insurance

Those using life insurance to benefit their communities typically do so in one of two ways:  direct gifts and indirect gifts.

Direct Gifts

Making a direct gift of a life insurance policy can significantly benefit a charity and it can be accomplished in a variety of ways:

Transfer an Existing Life Insurance Policy

A gift of an existing policy may allow the donor to take an income tax deduction.  The value of the policy for the purposes of taking a deduction will generally be the lower of the cost basis of the policy or its fair market value.

Since the charity receiving the policy may prefer or need cash, the charity could either surrender the policy or sell the policy in a life settlement, rather than hold the policy until the death of the insured.

Name Charitable Organization as Policy Beneficiary

A charity can be named as beneficiary of an existing life insurance policy but because the donor still retains full ownership rights, including the right to change the beneficiary, no income tax deduction is allowed.  In this case, the life insurance proceeds are included in the donor’s taxable estate, but the estate receives an estate tax deduction at the time of death for the full value of the proceeds transferred to a charitable organization.

Charitable Gift Annuity

If the donor wants to give money to a favored nonprofit organization as well as receive an income stream, a charitable gift annuity can make sense.  A charitable gift annuity is a contract between the donor and an IRC §501(c)(3) public charity where the donor gives cash, securities or other assets to the charity and receives a charitable tax deduction up front. The institution invests the money and returns some of it to the donor in fixed payments for the rest of your life.

While a donor looks forward to a long life of annuity payments, by living longer, less of the donor’s original gift is available to the charity.  Charities address this by purchasing an immediate annuity from a top-rated life insurance company.  An immediate annuity is likely to have a better payout rate so the donor benefits and the charity is protected from the responsibility of making direct annuity payments to a donor who may live too long and exhaust the remainder.

Charity-owned Life Insurance

One may make cash gifts that are equivalent to the premium amount on a new or existing life insurance policy owned by a charity.  Like any cash gift, an income tax deduction is available for the amount of the cash given directly to the organization.

Cedar Point Financial Services LLC can help potential donors decide if a direct gift is best suited to carry out charitable wishes and in what form.

Indirect Gifts

Indirect gifts to charitable organizations using life insurance are usually accomplished using charitable trusts.  Charitable trusts are often referred to as ‘split-interest trusts’ and often retain a benefit for the donor or the donor’s family. 

Charitable Remainder Trust (CRT)

A CRT is an irrevocable tax-exempt trust that pays a stream of income to the donor or someone the donor designates, and then pays whatever is left at the end of the trust term (the ‘remainder’) to a designated charity.  The income stream payable from the trust can last for life or a specific number of years (not to exceed 20 years).

The income stream payable is determined in one of two ways.  The first way is when a Charitable Remainder Unitrust (CRUT) pays a fixed percentage based on the annual value of the trust.  The second way an income stream payable occurs is when a Charitable Remainder Annuity Trust (CRAT) pays a fixed dollar amount each year based on the value of the trust assets when the trust was first created. 

One of the primary advantages for a donor in creating a CRT is the ability to claim an income tax deduction, which is generally equal to the value that is expected to pass to the charity – the remainder value at the end of the trust term.  CRTs are often used to diversify a donated concentrated stock position while permitting the donor to use trust income to purchase life insurance for the benefit of children and/or grandchildren to replace the value of assets passing to charity.

Charitable Lead Trust (CLT)

Similar to a CRT, a CLT is set up for the donor’s lifetime or for a period of years.  However, it is the charity that receives an income stream from the CLT for the trust term (known as the ‘lead interest’).  At the end of the term, the donor or their designee will receive the balance, or remainder, of the trust assets.

The amount of income payable to the charitable organization using the trust term is based upon whether the organization has a ‘unitrust’ interest or an ‘annuity’ interest.

With a Charitable Lead Unitrust (CLUT), the charity will receive a fixed percentage of income each year based on the annual value of the trust assets like the CRUT discussed earlier in the article.

With a Charitable Lead Annuity Trust (CLAT), the charity receives a fixed amount each year based on the value of the trust assets when the trust was first created like a CRAT, as discussed earlier in the article.

Cedar Point Financial Services LLC can help potential donors decide if an indirect gift is best suited to carry out charitable wishes and in what form.

Let us Help Fulfill Your Charitable Wishes

Life insurance can be an exceptional tool for achieving the fulfillment of philanthropic goals.   Not only can life insurance allow for a substantial gift to support the community and further a worthwhile cause, a donor and his or her family may also benefit from tax rules that apply to gifts of life insurance.   At Cedar Point Financial Services LLC, we help our individual clients maximize the benefits from their charitable giving and we also assist charities in structuring their campaigns and maximizing their fundraising.