C3 Financial Partners

Fulfilling Charitable Wishes Using Life Insurance

Winston Churchill said, “We make a living by what we get, we make a life by what we give.”  Giving to your community can provide many benefits and opportunities, both to the philanthropic organization and to the donor.  The organization benefits from a donation that can further its mission while the donor may receive tax benefits and gain satisfaction from pursuing philanthropic goals.  The ways in which donations involving life insurance can be made to charitable organizations vary and can be tailored to achieve specific planning objectives.

There can be a number of benefits to a donor using life insurance to fulfill charitable planning goals.

  • May receive a charitable income tax deduction.
  • Potential gift tax savings and/or reduction in estate tax owed.
  • Possibility to retain an income stream from a transferred policy for life or a period of years.
  • May avoid capital gains tax on a highly appreciated asset.
  • May replace 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

A direct gift of a life insurance policy can benefit a philanthropic organization significantly and 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.

Many families choose to transfer existing policies to foundations they have established to carry out their charitable wishes.  If the policies are owned by life insurance trusts, the trustee can transfer them to the beneficiaries – usually the next generation – who, in turn, gift the policies to the family foundation.  This strategy reduces the likelihood of any ‘self-dealing’ conflicts.

Name Philanthropic Organization as Policy Beneficiary

A charitable organization 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 will be included in the donor’s taxable estate, but the estate should receive an estate tax deduction at death for the full value of the death proceeds transferred to a charitable organization.

Charity-owned Life Insurance

Cash gifts equivalent to the premium amount on a new or existing life insurance policy owned by a charitable organization can be made.  Like any cash gift, an income tax deduction is available for the amount of the cash given directly to the organization.

C3 Financial Partners 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.  For example, if the value of the trust assets in year 1 is $20 million and the trust is required to pay the donor or their designate an amount equal to 5% of the trust’s asset value (“unitrust interest”), the income payment would be $1 million.  If the value of the trust assets decreases in year 2 to $18 million, the income payment would be $900,000.

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.  For example, if the donor contributed $20 million to a CRAT and retained a 5% annuity interest, the donor or their designate would receive $1 million a year, regardless of whether the trust assets increase or decrease over the subsequent years.

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 on to a 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.

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 designate, 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 a CRUT.

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

Many of the rules that govern the operation and taxation of CLTs differ significantly from those of CRTs.  For example, CLTs are not tax-exempt trusts; instead, CLT income is either taxed at the trust level or taxed to the donor, the grantor.  In order to receive an income-tax deduction, the CLT must be designated as a Grantor CLT.

C3 Financial Partners can help potential donors decide if an indirect gift is best suited to carry out charitable wishes and in what form.

Carry out Charitable Wishes Today

Life insurance can be an excellent tool for charitable giving in pursuit of philanthropic goals.  Not only may 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 C3 Financial Partners, we help our clients gain clarity in their goals and objectives, confidence that they are making the right decisions, and coordinating our efforts with our clients’ other advisors.

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