Over the past number of months I’ve had a handful of cases come across my desk involving life insurance and charity. As is so often the case, some of the transactions ended up as case stud-ies in what to watch out for.
I understand that not everyone is going to have the same attitude regarding the intersection of life insurance and the non-profit sector but I am somewhat surprised at the black and white policies of charitable organizations I encounter at times. Many charities and non-profits have a policy to simply cash out life insurance policies which are donated. I can’t think of a more short sighted stance. Of course each and every transaction should be evaluated on it’s own merits relative to required premiums, guarantees, life expectancy, use of money, etc. It also doesn’t help that so many non-profits have been burned by life insurance over the years the same as so many consumers have.
When a critical mass of agents and consumers put policies in force with a material lack of understanding and then do not manage them effectively over time (or know that they should), too many of these policies are collapsing and leave the charity with nothing. However, anything short of a case by case analysis of potential donated policies could be throwing money out of the window, especially in the era of low/no cash guaranteed universal life contacts.
Following are a few things to keep your eyes open for:
1. I was working with a policy owner who transferred his policy to his family foundation and intended to fund it so the death benefit acted as an ancillary, diversifying investment. It was only afterwards that he mentioned “The Jones Family Foundation” wasn’t the actual name of the family’s private foundation; it was the moniker of the Fidelity Donor Advised Fund he had set up but neglected to tell anyone. Fidelity never showed up anywhere in the conversation or paperwork.
Once this was understood I made an anonymous call to Fidelity and discovered they would simply cash out any life insurance as a matter of policy, directly in conflict with the stated goals of the donor. We had to unwind the transaction and get it to a Foundation which would work with him.
2. Recently, I received a call from a business owner who was directed to me by an agent. The gentleman explained to me that in 2016 he donated a life insurance policy to his alma mater’s foundation. This was an old whole life policy from when he was a child, many decades ago. It had a cash value of $117,000 and, as most consumers would, he reasonably expected a deduction for such. Working with his accountant on his taxes he learned this isn’t the way it works and called me for advice.
Tax law states that the amount deductible as a charitable contribution is limited to either the fair market value of the policy or the cost basis, whichever is less. His cost basis is $14,000. That’s a kick in the gut. Furthermore, if the value of the donated asset is great-er than $5,000, the donor must obtain a qualified appraisal, further eating into any tax savings on the $14,000.
Fortunately in this situation the donor wasn’t dependent on the deduction and he remains satisfied that his alma matter will benefit from the death benefit at some point but for an-other taxpayer in a different situation, this could be devastating.
As a warning, if the policy had a significant loan on it, a donation of the policy to a charity could actually result in an income tax payable by the donor.
3. In an interesting situation last year I was called by a representative of a community foundation regarding a benefactor’s desire to donate a policy. The primary reason for the call was to pass something by me as the representative was suspicious of what was going on. As an aside, it’s interesting how many calls I get which are initiated by an advisor’s suspicion of something he or she is hearing or observing.
The policy was a traditional whole life contract with a massive loan. The loan was a significant majority of the gross cash value and was driving the policy into the dirt. If the pol-icy collapsed there would be a massive income tax on phantom gain. What I imagine happened was that the agent told his client to donate it right away so it would fall apart on the foundation’s watch and he wouldn’t suffer the consequences. I’ve heard this a number of times over the years.
One little problem… that’s not the way it works. Donating policies with a loan fall under bargain sale rules as they are part gift and part sale. The “forgiven” loan will result in tax-able ordinary income to the donor. The end result is that if the donor thought he was escaping a tax disaster, he is not getting out from under it. If he didn’t figure this out now I can only imagine the gut punch next January when the tax details from the insurance carrier hit his mailbox.
Though I am a strong proponent of incorporating life insurance into charitable planning as part of a diversified approach, the above scenarios show that meaningful attention must be paid to the details or things may not pan out as expected.
When it comes to life insurance and charitable giving, as is often the case, there is the good, the bad and the ugly and sometimes it is difficult to differentiate. As an example, even something as controversial as life settlements could, if employed appropriately, be a bonanza to a donor and charity alike. In fact, not identifying such opportunities may result in regret and strained relation-ships if lost potential was discovered after the fact.
The good news is that you don’t have to remember this all yourself. Working with a consultant to navigate these waters and research projects and opportunities may be worth its weight in gold.