Gifting a life insurance policy creates immediate tax savings, legacy

Individuals looking to make a lasting impact on their favorite charity should consider donating their life insurance policy. The value of these policies often exceeds what could be given through cash or stocks while creating an immediate tax benefit for the donor.

“This is a strong strategy for donors who don’t want to part with liquid assets in the short term,” says Michael Zeleznik, director at GDK & Co.

Smart Business spoke with Zeleznik to learn more.

How can one gift a life insurance policy? What are the options?

When donating a life insurance policy to charity, a great method is a transfer of ownership. Some policy owners name a charity as a beneficiary, but that’s less beneficial to both parties.

To donate a policy, the owner completes a form to transfer ownership to a charitable organization. The charity will then issue a receipt for that gift.

If the value of the policy exceeds $5,000 and the donor wants to claim a charitable income tax deduction, the donor must have the insurance policy appraised. The charity and the appraiser must then sign IRS Form 8283, which the donor attaches to his or her income tax return for the year in which the donation was made.

It’s best to donate permanent life policies. Some permanent policies have significant cash value, so much so that there are no more premium payments needed. That is the ideal policy to donate. Policies of modest cash value can also be donated, and then the donor makes annual tax-deductible contributions to the charity to pay the premium.

In what circumstances does gifting a life insurance policy to charity make sense? Why not gift cash or stock?

Policy owners sometimes find that their policy’s death benefit isn’t as valuable to their family as it once was. Or, they may have enough retirement income to live comfortably. In such cases, donating their policy to charity may make sense.

Cash and stocks are great donations, but the proceeds from a life insurance policy typically have a bigger charitable impact.

What are the benefits for the policy owner?

The policy owner gets an immediate income tax deduction for the year in which the donation was made. Depending on how the policy was structured within the donor’s estate, removing that asset might also offer some relief on the amount of estate tax due.

In the case that the donation is large enough that it exceeds the amount one is permitted to claim as a charitable deduction in a given tax year, the excess can be carried forward and used for a total of up to six years.

What misconceptions do donors hold when it comes to gifting an insurance policy?

Some donors mistakenly believe that the amount of the death benefit of their policy is guaranteed, not realizing that the cash value can go up or down.

The amount of the charitable deduction is another aspect many people misunderstand. Let’s suppose a policy has a $100,000 death benefit, its fair market value is $80,000, cash surrender value is $78,000, total premiums paid were $64,000, cost of insurance charges were $10,000 and tax basis is $54,000. It’s not obvious, but the charitable contribution deduction is $66,000.

Also, many donors don’t realize their full range of charitable options. Most donate their life insurance policy to a single charity. That’s a good thing, but those donors who wish to leave a legacy or support multiple nonprofits should consider gifting their policy to start their own charitable fund. Community foundations offer a range of charitable fund options, including scholarship funds and funds designated to one or more specific charities, a community or field of interest. Donors can then support the causes or charities they love year after year, forever.

Though donating a life insurance policy involves some complexity, it’s not anything insurmountable. With a good adviser and the help of a good development department, it can be done efficiently and effectively.

Insights Philanthropy is brought to you by Akron Community Foundation