For millions of Americans, “charity begins at home.” That’s where they’ve decided to make a difference by donating money to local religious, educational, social, or cultural organizations. In addition to the immense satisfaction that comes from giving to others, when done as part of an overall estate plan, charitable giving can provide tax benefits for the donor and his or her estate.
Charitable Gifts of Life Insurance
Gifts of life insurance have some unique advantages:
• Life insurance is a contract and passes outside the will by beneficiary designation, so it generally cannot be contested in probate proceedings.
• Since the payment of a life insurance policy death benefit to a named beneficiary other than decedent’s estate is not part of the probate process, it is private, not a matter of public record like assets passing by will.
• Donor is eligible for an income tax charitable deduction when he/she transfers an existing life insurance policy to charity.
• Ability to leverage a charitable donation through the death benefit.
• There are no probate delays.
• Other assets are kept intact for the donor’s family.
Gifts of life insurance can be made in essentially two ways. Under the first, the insured is the owner of the policy and the charity is the beneficiary. This arrangement is used when an insured/donor desires to retain control over the insurance policy. Under this arrangement, the premiums paid are not eligible for an income tax charitable deduction. Additionally, since the insured owns the policy at death, the death benefit will be includable in his or her gross estate under IRC Section 2042, but it will be 100% deductible from the estate, since it is payable to a charity (IRC Section 2055).
Under the second, the charity is owner and beneficiary. Unlike the situation where the insured retains ownership, the premium may be income tax-deductible within IRS guidelines. State “insurable interest” laws must be checked to determine if a charity can be the initial applicant of life insurance on the life of a donor.
If the donor gives an existing policy to charity, the lesser of the fair market value of the policy or the policyholder’s basis (generally the premiums paid) is eligible for an income tax charitable deduction. (See IRC Section 170(e)(1)(A), Treas. Reg. 25.2512-6(a) and Tuttle v. U.S., 436 F.2d 69 (2d Cir. 1970). Additionally, future gifts of cash to the charity for premium payment purposes are also eligible for an income tax charitable deduction within IRS guidelines.
Charitable Remainder Trusts (CRTs)
If the prospective charitable donor is looking for a way to generate income, reduce estate and income taxes, defer taxes on gains, and make a significant charitable contribution without reducing his or her family’s inheritance, a charitable remainder trust and a wealth replacement trust may be the right tools. These trusts can allow an individual to make a gift to a charity while retaining an interest in the gifted asset during his or her lifetime.
CRT Mechanics and Tax Aspects
As a general rule, it is best to fund a CRT with an asset that, if sold outside the trust, would produce substantial long-term capital gains tax. After the trust is executed, the donor transfers this appreciated, low- or non-income producing asset to the CRT. The CRT sells the asset and gives the donor an income stream for life, for a term of years, or for joint lives. At the death of the donor (or the donor’s named non-charitable income beneficiary if other than the donor) the remaining trust assets pass to the charity. Here’s how it works:
• Upon creation of the trust, the donor is eligible for a current income tax deduction based on the present value of the future amount passing to the charity.
• No tax on the gain is paid by the trust when it sells the asset, since the trust is exempt from such tax when it sells the asset.
• The donor receives an income stream and pays income taxes on the income as received.
• At the end of the trust term, the remainder passes to the designated charity and estate taxes may be reduced, since the remainder passing to charity has been removed from the estate.
“Wealth Replacement” Trust
As indicated, the remaining assets in the trust eventually pass to the charity and not to the donor’s heirs. The income tax savings produced by the charitable donation combined with the income generated by the trust can be used to pay premiums on a life insurance policy owned by a properly formed irrevocable life insurance trust sometimes known as a “wealth replacement” trust. The life insurance policy in this trust replaces the value of the assets that pass to the charity in the CRT. Since the life insurance is purchased and owned by the irrevocable trust, the proceeds should be income and estate tax free. The donor’s family is, therefore, made whole.
Prepared by MetLife
Delivered courtesy of Wayne Kuykendall , Financial Services Representative with Strategic Financial Partners, an office of MetLife.
For more information on the financial, risk and wealth management strategies that Wayne Kuykendall provides, please contact him at256-777-4524, wayne.d.kuykendall@strategicfinancialpartners.com , and 105 S Marion Street Suite 202, Athens, AL, 35611.
