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Thursday, May 2, 2024
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Case Studies |
Planning Gifts of Life Insurance: Current, Deferred, Contingent & Split Interest, Part 1 of 6
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Case:
Many years ago, when Dr. Mimms was just a budding young surgeon and father, he decided to purchase a life insurance policy on his life "just in case." At that time, he had two children and a very large mortgage. Therefore, he sought some financial protection should anything happen to himself, since he was the only income earner and his wife stayed at home to raise their children. Consequently, he purchased a $1,000,000 policy with annual premiums of $10,000.
Now the Mimms' financial picture is quite different. They have an estate of $5 million, which consists of a $1.25 million home, $2.5 million IRA, and $1,250,000 of various assets. Both of their daughters' schooling expenses have been set aside in education savings accounts. Finally, through the use of credit shelter trusts, bequests, and testamentary charitable remainder trusts, their estate plan was arranged so that no estate tax would be payable at either death. The Mimms are very philanthropic and want to make a substantial current gift to their favorite charity.
Question:
Since the Mimms no longer need the life insurance policy for "just in case" reasons, can they give the paid-up policy to their favorite charity? What are the tax consequences of making such a gift?
Solution:
An outright gift of an 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). (Ed. See Sec. 170(e) which deals with gifts of ordinary income property.) After contacting the Mimms' insurance company, it was determined that their policy is worth $400,000. The Mimms have paid premiums for 25 years. Thus, their basis in the policy is $250,000 (25 x $10,000 annual premium). In many cases, the donor's premiums paid for the policy will be less than the policy's value. Thus, the Mimms are entitled to a charitable deduction of $250,000. This deduction will be limited to the 50% AGI limitation (not the 30% limitation) because there is no capital gain element involved in the charitable deduction. Therefore, it is treated similar to a cash-type of gift.
The Mimms love the tax and charitable benefits of the plan. As a result, they transfer all ownership and rights in their policy to the charity. This was accomplished by contacting the insurance company and filling out the proper change of ownership forms provided by the insurer. Once the charity is the owner of the policy, charity may hold or surrender the policy. In this instance, after discussions with the Mimms, it was determined that charity would surrender the policy and use the funds for current needs. In the end, Dr. Mimms' "just in case" plan provided peace of mind, excellent tax savings and a substantial gift to his favorite charity.
Editor's Note: In general, the appraisal rules and IRS Form 8283 require an appraisal of property if the charitable deduction 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 impractical, 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. However, if an independent appraisal is desired, an insurance appraisal service is available at www.deathandtaxes.com.
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