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Thursday, May 2, 2024
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Case Studies |
Get a Life (Insurance Policy) and Give it Away
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Case:
Dr. Eleanor Crane, 55, has been director of research at a local hospital for the past 16 years. She is the first woman director in the hospital's history and was honored several times by her colleagues for outstanding medical research. During her tenure as director, she and her spouse, August, raised two wonderful daughters, Denise and Laura. In fact, both of her daughters are medical students and wish to follow in the prestigious steps of Dr. Crane (a.k.a. Mom).
Twenty-five years ago when Dr. Crane was just a budding young resident and mother, she and Tom decided to purchase a life insurance policy on her life "just in case." At that time, they had two children and a mountain of school loans between them. Therefore, they sought some financial protection should anything happen to Eleanor, who was the high-income earner in the family. They consequently purchased a $500,000 policy with annual premiums of $5,000.
Now, the Cranes' financial picture is quite different. They have a $7 million estate, which consists of a $3.5 million home, $2.5 million IRA and $1 million of various assets. Schooling costs for both daughters have been set aside in a bank account. Finally, through the use of credit shelter trusts, bequests and charitable remainder trusts, their estate plan is arranged so that no estate tax will be payable at either death.
Question:
Since the Cranes no longer need the life insurance policy, can they give the paid-up policy to the local hospital's medical research foundation? What are the tax consequences of making such a gift?
Solution:
The Cranes' outright gift of their insurance policy will produce a charitable income tax deduction equal to the lesser of the policy's value (i.e., interpolated terminal reserve value or replacement cost) or their basis in the policy (i.e., premiums paid). Here, the policy is worth $200,000 and the Cranes paid premiums of $125,000 (25 years x $5,000 annual premium). In most cases, what the donor paid for the policy will be less than the policy's value. Thus, the Cranes are entitled to a charitable deduction of $125,000. This deduction will be limited to the 50% AGI limitation (not the 30% limitation) because their deduction was based on what they paid for the policy and not its appreciated value.
It is important to note that if the Cranes had transferred the policy in exchange for a CRT or a gift annuity the analysis would remain the same. However, the $125,000 value would be used to calculate the charitable deduction.
Editor's Note: Substantiating this charitable deduction is a bit unclear. The technical appraisal rules and IRS Form 8283 require an appraisal of property if the deductible gift exceeds $5,000. The natural choice for an appraiser of this policy is the issuing insurance company; however, the appraisal rules require an independent appraiser. This requirement for independence seems excessive, since the insurance company is in the best and easiest position to value the policy. Moreover, since most deductions will be limited to basis, there is little room for abuse by donors.
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