Leveraging Life Insurance for Charitable Giving

Jeff Root Jeff Root Posted in Advice

What do Warren Buffet, Bill and Melinda Gates, Michael Bloomberg, and the heirs of Sam Walton have in common?

They have given away billions of dollars through foundations and nonprofits to make the world better.

Many of us would also like to leave a lasting legacy in our communities through charitable giving.

But unless we’re Buffet, Gates, or Bloomberg, finances can get in the way.

We have to save for retirement, continue paying the bills, maintain our property, help our children, care for our aging parents, and pay off debt.

The list of demands seems endless, and it can squeeze “leaving a legacy” out of the picture. That’s why many people turn to life insurance to fund legacy giving.

Life Insurance for Charitable Giving

Using life insurance to leave a legacy through charitable giving can take many forms:

  • A scholarship in honor or in memory of someone you love or admire.
  • A gift to an existing nonprofit providing a need in your community.
  • Donating seed money to start a new nonprofit addressing an unmet need.
  • Funding the land purchase and legal fees associated with setting up a land preserve.
  • Giving your local library money to buy more resources or build a new wing, or a new branch.
  • Supporting a local hospital or faith community.

This list really could go on for the rest of this post. It’s limited only by your imagination and your ability to make funds available.

Life insurance can’t enhance your imagination, but it can help you leverage a significant amount of money to donate without tying up funds you need elsewhere.

Using Your Life Insurance As A Charitable Gift

Life insurance can be surprisingly agile as a source of charitable giving. If you’d like to use your current policy to make a legacy gift, an estate planner or financial advisor will be a tremendous help.

To make a charitable gift using life insurance while you’re still alive, you may not need as much advice. But it never hurts to know exactly what you’re doing, especially if you plan to take a tax deduction as a result of your gift.

Since we don’t know your exact situation, we’ll take a look at several ways to use your existing life insurance policy to help a charity:

Donating Your Policy Itself

Someone who needed a lot of life insurance earlier in life but no longer needs the coverage can simply donate the policy to a charity.

Let’s say you have $500,000 in coverage and you no longer have dependents, you’re not leaving behind any significant debt, and you have other money set aside for final expenses.

In that case, you’d have a few options:

  • You could simply stop paying the premiums and let the policy lapse.
  • If it’s a permanent life insurance policy you could cancel the policy and claim the cash value.
  • Or you could donate the policy to the charity of your choice and reap some significant tax benefits.

If you chose to give away your policy, you could deduct the gift from your taxable income the following spring. (You couldn’t deduct the face value; just the market value or cost basis, which we’ll get into below.)

Also, you could deduct the donated policy’s future premiums, assuming you continue paying them rather than having the charity keep the policy active.

When you die, the charity would receive the entire face value of your policy.

Naming the Charity Your Beneficiary

A similar strategy would be to retain the policy but change its beneficiary so a charity, foundation, or university receives the benefit when you die.

Changing your beneficiary to a charity does not offer you a current tax advantage, but it has other advantages:

  • Confidentiality: You could keep your gift a secret from your family and friends, and possibly from the charity itself.
  • Security: Changing the beneficiary creates a contract which can keep others from contesting the gift after your death.
  • Estate Reduction: Although you can’t deduct the premiums, you could prevent the death benefit from adding to your taxable estate if you didn’t have another beneficiary.

Giving Dividends to a Charity

More elaborate, whole life policies can generate dividends for policyholders. The dividends come from the insurance company’s profits. Not all policies pay dividends, only “participating policies.”

Many people use their dividends to reduce annual premiums or to buy additional coverage.

While donating your dividends won’t generate a gift as large as an entire insurance policy, dividends can provide regular, ongoing gifts.

And you could write the dividend donations off your taxes. Keep in mind the IRS won’t tax you on the dividends if you don’t donate them.

Why? Because the dividends come from a profit the insurance company made from your policy. They’re essentially an overpayment of premiums.

Buying Life Insurance for Charitable Giving

The scenarios above assume you already have coverage you’d like to redirect to a charity to improve your community either now or after you’ve passed away.

If you don’t have coverage but you’d like to use life insurance to enhance your ability to give, you’d first need to buy a policy.

By its nature, life insurance provides an efficient way to leverage future giving power: By paying a regular premium, you can control a source of money that far exceeds the premiums.

You will need to make some decisions as you shop for coverage:

Term vs. Whole

For most people, a whole life insurance policy works best as a source for charitable giving.

Since the policy lasts the rest of your life, you won’t have to worry about the coverage lapsing or the premiums skyrocketing when the term expires.

Whole policies also accrue cash value, which can give you more giving power. Participating whole policies can generate dividends you can donate, as we discussed above.

Coverage Amount

A larger coverage amount can mean a larger gift for the foundation or charity you’re planning to help. But larger coverage amounts also require higher premiums.

Whole policies usually cost significantly more than term policies for the same coverage amount because they last the rest of your life and include additional cash value.

Medically underwritten policies give you more coverage for less if you’re healthy. No-medical-exam policies can help someone with health problems find coverage, though generally with higher premiums.

Even people with chronic diagnoses such as heart conditions or diabetes can now find coverage with help from an independent insurance agency like ours.

Quality of Coverage

Not all insurance coverage is created equally. To help you know whether you’re getting quality coverage, independent ratings agencies such as A.M. Best and Moody’s grade insurance companies.

Generally speaking, grades of A or higher (A+, AA, etc.) mean the insurance company has a better financial standing.

A company with low or failing grades may have trouble paying the benefit when your charity tries to file a claim.

Charitable Giving Riders

If you still need a large amount of coverage to protect your family but you’d also like to use insurance as a source for giving, consider a charitable giving rider.

These riders direct a small percentage of your policy’s benefit to a charity of your choice if you die with coverage in force.

Rider is the life insurance word for an extra feature. Adding this rider would also add an extra fee onto your regular premium payment.

The resulting charitable gift tends to be a small amount percentage — usually 1 or 2 percent — of your death benefit. For a $1 million term policy, a 1 to 2 percent gift would equal $10,000 to $20,000. Policies with lower death benefits don’t tend to qualify for this rider.

Buying a rider may be the simplest way to give money using a life insurance policy. But it’s not the most powerful or efficient way to leverage your coverage.

Tax Implications of Donating Life Insurance

Donating an entire life insurance policy to a charity can create a large tax write-off, but it’s typically not as large as people think.

A lot of people think they could write off the face value of a donated life insurance policy, whether the death benefit is $25,000, $500,000, or $1 million plus.

This isn’t true. Instead, the IRS will let you write off either the market value of your policy or your cost basis for the policy, whichever is the lower amount.

“Cost basis” means the amount you’ve paid so far in premiums since you bought the policy. “Market value” can be harder to define.

It usually includes a whole policy’s cash value minus the premiums you’ve paid so far (plus any dividends you’ve received).

If your policy’s cash value equals $150,000 and you’ve paid $50,000 in premiums, your market value could be $100,000.

However, for tax write-off purposes the market value wouldn’t matter in this case. You could claim only the cost basis ($50,000) since it’s the lower of the two figures.

Also, keep in mind the IRS will typically limit life insurance donation write-offs to 50 percent of your adjusted gross income in a given year.

If your adjusted gross income was $60,000, you could deduct only $30,000 from your life insurance donation, even though its cost basis is $50,000.

If you’re still paying the premiums on a donated policy, you can write off the cost of your premiums since you no longer own the policy. Before counting on a tax deduction from a life insurance donation, make sure you’ve checked with a tax professional or thoroughly investigated your tax situation.

Bottom Line: Life Insurance as Legacy

Truth be told, we can all leave a legacy through our relationships with others.

Co-workers, family members, friends, people you encounter in everyday life — you never know how you’re impacting other people.

Still, charitable giving appeals to people who want to leave a more specific kind of legacy such as creating a scholarship fund or strengthening a foundation.

If you don’t have the financial flexibility to make this kind of gift — or if you’d rather retain your current financial standing while making a large gift — life insurance can boost your giving power.

It may not be the simplest use of life insurance. You’d do well to discuss it with your financial planner and your tax advisor. We also invite you to discuss it with our independent insurance agents.

As independent agents, we have the industry knowledge to help you find exactly the right policy to help make your giving dreams a reality.

Leave A Reply