Multiplying Your Charitable Giving with Life InsuranceSubmitted by AdvisorServe on January 21st, 2021
By Greg Freeman, JD, ChFC, CLU, RICP, CLTC
We have seen how strong the relationship between an advisor and his or her client can be when charitable giving is part of the planning process. When you help clients engage with organizations and causes that promote their values, you are connected to them on a much deeper and more rewarding level. After all, you are helping them pursue and support part of their life’s purpose.
Of course, many of your clients may not have the financial resources to have a large impact on a charitable organization, but they would love to be able to do so. That’s where life insurance can be everyone’s friend. That same person who can’t give away say, $1,000,000 to their charitable cause is often in a position to give away an annual premium on a $1,000,000 life insurance policy. This is an example of planned giving for middle America. I would suggest that the reason this is not a widespread strategy is because not many advisors are even putting it on the table. Clients are unaware of how they could have a significant impact on a worthy cause.
By making the charitable entity the owner of the policy, you have just positioned the premiums to be tax deductible as charitable gifts. Also, in those cases where there is an existing life insurance policy that is transferred to the charity, there is the additional up-front deduction for the value of the policy. So, now the client is not only gaining the advantage of the tremendous leverage of a death benefit versus the premiums paid, but there are also valuable tax deductions making the net cost even lower. Please note that transferring policies with existing loans can cause unexpected tax issues and we typically stick with policies that are free of loans.
The safest strategy is to use a permanent policy rather than term, because we are talking about creating a large gift upon the death of the donor, which is more likely to occur after the maximum age usually covered by term insurance. Premiums are totally dependent on age, number of years to pay, health, type of policy, and other criteria. Just for example, a male, age 40, might pay $7,500 per year to fund $1,000,000 of coverage. Females pay less, as do younger clients, and premiums are much less when we insure both spouses on one policy, for example. The point is that the deductible cost is very unlikely to put a dent in what is left for the family and would have minimal impact on current lifestyle. However, the payout is fantastic and clients will be quite happy about the result set up for their most important causes.
The additional planning aspects of this strategy are also very exciting. First, the policy could be funded with appreciated assets, such as stocks. The donor could make annual gifts of appreciated stocks to the charitable entity to be liquidated and used to pay premiums. As advisors know, the client avoids the capital gains tax and receives a full income tax deduction. This makes the cost of maintaining the life insurance policy even lower. As of the time this article is being written, we are anticipating a potential increase in the tax to be assessed against capital gains, giving us even more reason to run a strategy such as this.
Things Can Come Up
While I will share a good approach below, there have been some issues with life insurance gifts to particular charities. One of the areas of concern is what happens when the policy underperforms and needs more premiums. Related to that question is what the charity does when the donor stops paying any more premiums, even when more funding is needed. The need for more funding beyond what the donor is providing can force the charity to make a decision on whether to supplement the policy with its own funds, reduce the coverage to a level that remains funded, or drop the coverage altogether.
From the donor’s perspective, another major question arises when the donor’s charitable objectives change. Examples may include when a school receiving the policy takes actions which are inconsistent with the donor’s wishes, or when the donor decides to change churches and has no interest in seeing the death benefit paid to the former church.
An Easy Answer
A great way to address these issues is to make the gift of the life insurance to a donor advised fund. This gives the donor the greatest flexibility to adjust funding approaches and policy design in the future. It also allows the donor to change the ultimate beneficiaries. Yes, the policy is still owned by the sponsoring charity and will pay its proceeds to that charity, but the donor advised fund is the ultimate decider of where the death benefit is to be distributed. Technically, donor advised funds do not make decisions, but practically, their wishes carry great weight so long as the entities receiving funds fit within the guidelines of the sponsoring organization. In practice, one of our favorite donor-advised fund organizations, National Christian Foundation, allows the donors to maintain a letter with NCF expressing their wishes for the distribution of the death benefit. The letter is easy to replace if there is ever a change of charitable targets.
Policy management inside the donor-advised fund is also under active donor participation. The policy is not lost to the balance sheet of a larger organization, never to be seen again by the donor. Because he or she will see this policy in their active account, the donor will have much more awareness and flexibility to decide how to fund future premiums and whether to modify the death benefit as needed. This will also protect the donor from adverse decisions the charity might have otherwise made.
Let’s not stop here. Many donor-advised funds can have successor donors. Parents can involve their children in the giving fund while everyone is alive, and they can also set up the account to continue after their death. At that point, the children can make the decisions on which charitable entities to support, either with 100% of the fund or with that share that continues after any last distributions directed by the parents. Where life insurance has been included in the funding, the death benefit can significantly increase the donor advised fund. This new life for the fund not only enables another generation of giving decisions, it also keeps the financial advisors involved. Since many organizations will allow the wealth manager to direct the investments while the donors are alive, those same wealth managers will have a larger and continuing donor advised fund to manage in the future.
When you think of how to build a strategy for your clients to maximize their charitable giving, don’t forget this life insurance strategy. Your clients will be excited about this significant way to accomplish more of their goals, and your role as the trusted advisor will rise to a much higher level.