Last week I spent some time talking about different forms of charitable gifting. This week, I would like to expand on charitable gifting using life insurance.
Most often when we donate money to charities, we do it in the form of a direct contribution. Typically, someone knocks on your door or solicits you through the phone. Sometimes, we give a little by leaving our change at the cash register or even by attending a fundraiser of some sort.
Charitable gifting with life insurance is much different. The most attractive advantage using life insurance is that it allows one to make a much larger gift to a charity.
When using life insurance for charitable gifting, it is important to consider different strategies and the different tax benefits. I offer three ways in which to help charities with gifts of life insurance:
- Designate a charity as the beneficiary of a life insurance policyThe most straightforward approach is to buy a life insurance policy where you are the owner of the policy and you designate the charity as the beneficiary. In this scenario, you would maintain control of the policy, but the charity collects the insurance proceeds upon your death. The death benefit qualifies as a tax credit on your final income tax return. In this scenario, the premiums for the life insurance contract are not eligible for a tax credit. Since there is a direct beneficiary designation, the life insurance death benefit would bypass the estate and avoid any probate fees.If you have an existing life insurance contract, you can simply change the beneficiary to your charity of choice.
- Name your estate as the beneficiaryThis scenario is similar to the first scenario in that you are the owner of the policy. However, instead of naming the charity as the beneficiary, you name your estate as beneficiary and simply leave instructions in your will that the proceeds of the life insurance policy will be paid to your choice of charities. Again, the life insurance premiums would not be eligible for a tax credit. However, the death benefit would qualify as a donation giving your estate a tax credit on the final income tax return. It is important to note that the proceeds would not be protected from probate fees, as the death benefit becomes part of the estate.
- Transfer ownership of the policy to the charityIn this scenario, if a life insurance contract is set up so that the charity is the owner of the life insurance policy, the premiums for the contract will qualify for a tax credit. However, since you are no longer the owner of the policy, the future death benefit will not qualify for a tax credit.If you have an existing life insurance policy with cash values, you can transfer ownership to the charity and name the beneficiary as the charity. Under this scenario, a tax credit is available for any cash surrender value that exists at the time that the policy is transferred. In addition, a donation tax credit will also be available for future payments of life insurance premiums.Since an actual disposition has been triggered at the time of transfer, there may be a tax liability if the cash surrender value exceeds the adjusted cost base of the policy. You will need to weigh the tax credit against the tax paid as a result of disposition. Also, since you’ve relinquished control, you will no longer have any rights (such as the right to change the beneficiary) in the policy.
Which solution is best for you?
Every situation is different. In most cases, you would choose scenario 1 over scenario 2 simply for the fact that you gain the benefit of probate fee protection. The outcome of both of these scenarios is virtually the same.
Other than that, the two most crucial issues are control and when you want the tax credits.
- Control. With scenario 1 or 2, you maintain control, as you remain the owner of the policy. As the owner, you can change beneficiaries whenever you want. In scenario 3, you relinquish your control when you make the charity the owner of the policy.
- Tax. It is important to determine when you want to utilize the tax credits. If you want to have tax credits every year while you are alive, you will need to take a hard look at scenario 3. You give up the control but you get to use the premiums in paying less tax every year. However, if you have a significant amount of accrued tax liabilities in the estate, you may be better off saving the tax credits for the future by using scenario 1 or 2.
There is no right or wrong and the decision depends on your personal needs.