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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 3 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 life insurance policy with annual premiums of $10,000.
Now the Mimms' financial picture is quite different. They have an estate of $4 million, which consists of a $1.25 million home, $2.5 million IRA, and $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 gift upon their death to their favorite charity.
Question:
Since the Mimms no longer need the life insurance policy for estate tax or "just in case" reasons, can they transfer their existing life insurance policy to charity? Assuming the Mimms pay the remaining premiums on the policy, can they make the payments directly to the insurance company (as opposed to contributing the premiums to the charity each year)? What are the tax consequences of making such a gift?
Solution:
Under state law, a donor may transfer an existing life insurance policy to charity. Generally, the transfer is completed by the donor irrevocably designating charity as the beneficiary of the policy and assigning all the incidents of ownership in the policy to charity. 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). (See Section 170(e) which deals with gifts of ordinary income property.)
After contacting the Mimms' insurance company, it was determined that their policy is worth $300,000. The Mimms have paid premiums for 20 years. Thus, their basis in the policy is $200,000 (20 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 $200,000. This deduction will be subject 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.
With respect to the remaining annual premiums, the Mimms will continue to make those payments. Usually, a donor will make cash contributions to charity each year, so that charity may maintain the policy. Because charity owns the policy outright, charity could (while unlikely) elect to surrender the policy at any time. Therefore, in some cases, a donor may prefer to make the premium payments directly to the insurance company and remove the charity from the premium paying process (i.e., control-oriented donor).
As a result of this plan, the Mimms will be entitled to additional charitable income tax deductions each year they pay the $10,000 insurance premium on the policy now owned by the charity. Generally, for cash-type gifts, the deduction will be subject to the 50% of AGI limitation. However, this plan may subject the Mimms to the lower 30% AGI limitation rule. Specifically, the donors' direct payment of the premiums may be deemed as a contribution "for the use of" charity rather than "to" charity. The 50% AGI limitation applies only to contributions "to" charity. After visiting with their CPA, the Mimms discover they can fully deduct each year's premium payment under either AGI limitation rule. Therefore, the Mimms decide to make the payments directly to the insurance company as planned.
The Mimms love the tax and charitable benefits of the plan. As a result, they transfer all ownership and rights in their policy to their favorite charity. This was accomplished by contacting the insurance company and filling out the proper change of ownership forms provided by the insurer. In the end, Dr. Mimms' "just in case" plan provided a peace of mind, excellent tax savings and a substantial gift to his favorite charity.
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