Gifting Life Insurance Proceeds [Reduce Taxes!]

Gifting life insurance proceeds is a terrific way to benefit your favorite charity when you pass away.

Not to mention the fact that you may even lower your income tax and reduce the bite estate taxes take with a little planning.

Unfortunately, a lot of people don’t strategize when they donate money to a cause, missing many opportunities to maximize their savings and the amount of money they donate.

Life insurance as a gift is a terrific tool for those of you that want to benefit a good cause. So let’s check out some creative ways you can give the gift of life insurance AND get some pretty sweet tax deductions while you are at it!

Gifting Life Insurance Proceeds: Should I Use Term or Permanent Products

This is a GREAT question.  Obviously there are different types of life insurance.

Term insurance is pretty unbeatable when it comes to price and flexibility. This is because it’s a temporary product designed to cover periods of vulnerability where income replacement is imperative to the financial survival of your family. It’s less expensive because it’s designed to only last for a set period of time and then expire. The goal is to live until the end of your term so your family never has to make a claim.

On the other hand, charitable organizations want donations they can count on. Term policies don’t offer coverage until the day you die so they are not suitable for gifting life insurance.

Tax deductions for the policyholder are also less clear. It’s possible the premiums may be deductible once the policy is transferred to the charity but it’s complicated.

My advice? Stick to permanent life insurance if you want to benefit a charity.

Exception – Term Life Insurance Rider

There is however one exception. Let’s say you purchase a permanent policy and for the benefit of your family, you can tack on an additional term life insurance rider. This extra coverage will provide x amount of funds to the charity you choose but only if you die during the period of coverage. It’s a cost-effective way to give a substantial gift without the hassle. You also retain complete control over the named beneficiary which means you can change your mind.

Once again the gift isn’t guaranteed but it’s a good way to use the flexibility and cost effectiveness of term to benefit an organization you love.

You Have a Permanent Policy That You No Longer Need

I’m going to start with the most obvious source for gifting life insurance proceeds. If you have an older policy that you no longer need to protect your family you can gift it to a charitable organization. There is a lot of upside to this from a tax perspective. Hey don’t get me wrong charitable giving should always be charitable first and foremost but the tax savings are pretty awesome.

Another perk? The tax-free death benefit bypasses your estate and flows directly to your charity of choice. This is a plus because administrative processes are time-consuming and expensive. Not to mention, if the proceeds pass directly through your estate, there will extra legal and state probate fees.

This is a perfect way to supersize your charitable giving with limited resources!

BEWARE: The government keeps a close eye on charitable giving for obvious reasons. So make sure you dot all of your I’s and cross all of your t’s or you won’t benefit from the tax savings. There is a lot of regulation in this area of life insurance planning.

Let’s take a closer look at how life insurance gifting can be set up:

Assign the Charity as Owner Of Your Policy

This is the most straightforward way to gift your life insurance policy to charity. Simply contact your independent life insurance agent and ask them to perform an absolute assignment of the policy to the charitable organization of your choice. The key is, you have to hand over 100% control of the policy to the charity otherwise you don’t qualify for the tax deduction which is equal to net premiums paid.

NOTE: The death benefit is not tax deductible for the donor and that’s not all. Although this is a quick and easy way to provide a charitable gift, there’s a drawback. An absolute assignment of your policy is irrevocable which means you can’t change your mind.

Naming a Charity as Your Primary Beneficiary

If you want to retain control over your life insurance policy, simply name the charitable organization of choice as a beneficiary. There are some pitfalls to avoid when naming a beneficiary. In this case, it’s very important that you designate the charity as a “revocable” beneficiary.

…this means you can still switch things up if you so desire. Hey, life changes and a little control never hurts. Unlike an ownership assignment, you can change your mind and replace the beneficiary at will. The good news is the death benefit still goes directly to the charity avoiding probate altogether…

This strategy is also good for your estate as the proceeds that pass to the charity are tax deductible not to mention the fact there is no estate tax – no matter how much money you leave to charity!

As an aside be aware that no income tax deduction is allowed for simply naming a charity as beneficiary. This benefit only passes when the interest is assigned to the charity.

Partial Interest

The thing to remember is if you maintain any sort of ownership in the policy, the death benefit is included in your estate. There may be some estate tax deductions available for the amount the charity receives, but it could cause your estate plan to collapse if you are not careful. In a nutshell, partial interests should be avoided if you can.

If you want to claim a gift or income tax deduction you have to assign 100% interest in the policy to your charity of choice. A partial interest does not qualify and will be denied.

Naming a Charity as Your Contingent Beneficiary

Contingent beneficiaries rule. Life happens and things don’t always unfold the way we want them to. A good way to make sure that your death benefits go to a cause you care about is to name the charity as a contingent beneficiary. This means if none of your family members are around to inherit the funds, the charity will get them. Failure to name any contingent beneficiaries could result in life insurance proceeds passing through your estate and NOT into the hands of family or chosen charity. The figure attached to unclaimed life insurance benefits is staggering. Don’t become a statistic.

1 out of every 600 people is the beneficiary of an unclaimed life insurance policy – Michele Lerner, BankRate.com

Designating Your Estate as Beneficiary

The main difference in this scenario is your estate maintains control over the death benefits. This means the funds remain in your estate and you instruct the executor(s) how to disburse them.

The death benefits qualify for a tax credit for your final income tax return which is terrific…

BUT don’t forget the funds are also subject to probate fees. Ultimately, this is a wonderful tool if you’re looking to provide a large sum of tax-free funds to help your beneficiaries to pay for taxes, fees or for them to provide money to a charitable organization.

Also, remember your premiums do NOT qualify for a tax deduction.

My advice? Be sure to create a plan before you select this option.

Gifting a Life Insurance Policy That’s Paid Up:

If you have a policy that still has outstanding premiums you can still gift the policy to a charitable organization.

Typically the policyholder assigns ownership of the policy to the charitable organization. BUT the key is the charity MUST have an insurable interest in you or you may not get the tax deduction (net premiums paid to date). Another issue with gifting a policy that has not been paid up is there’s no guarantee that the donor will continue to pay the premiums so it’s not as valuable to a charity as an interest in a paid-up policy.

You can also buy a policy with the specific goal of gifting life insurance…

…the thing is the value of your charitable gift in the first year is the gross amount of the premium you paid.

Split Ownership of the Life Insurance Policy

This strategy typically uses a Universal Life Policy to achieve two goals. The donor and charity both benefit from the life insurance policy proceeds.

For example, you retain an interest in the cash value accumulation while the death benefits are given to the charity. The death benefit can also be split between and the charity and the donor. In this scenario 50% of the premiums paid by the donor during their lifetime qualify for an income tax credit and when the donor passes away 50% of the death benefits go to the charity and 50% to the beneficiaries.

11 Benefits of Life Insurance as a Charitable Gift:

  1. Life Insurance Death Benefits are NOT taxable: Which means the organization benefitting won’t have to foot the bill. The charitable organization also avoids the delays and hassle connected to estate fees and probate if ownership of the policy is given to them.
  2. Premium Payments are Income Tax Deductible: Premium payments before or after the policy is gifted are deducted from your income taxes.
  3. Set It & Forget It: The death benefits are cast in stone as long as you pay your premiums. Stocks & real estate ebb and flow with the market. This is an added element of security.
  4. Maximize Your Giving: Because of the tax-free nature of life insurance death benefits, you can really maximize the financial impact of your gift.
  5. The Funds Are Outside the Grasp of Angry Family Members: There is no contesting the charitable gift of a life insurance policy. It’s a good way to secure your wishes.
  6. Protect the Funds from Creditors: Charitable organizations are more insulated against creditors.
  7. Borrowing Against Cash Value: One of the beauties of owning a permanent life insurance policy is the cash value accumulation feature. If you retain ownership of the policy you can borrow against it at any time and if you assign ownership to a charitable organization they can do the same. This gives the donor or recipient access to money earlier if need be.
  8. Anonymity or Accolades: You choose. If you don’t want anyone to know about your contribution this is your right – on the other hand, if you generosity works well for marketing reasons feel free to share your gift with the world.
  9. Skip the Income Tax: As the donor no matter how much the policy gains in value you won’t be subjected to increased income taxes.
  10. No Fuss No Muss: Think about it – you die and the money passes without issue to your charity of choice. If you leave money from your estate, real estate or securities there are administrative fees and delays. This truly is the best way to leave money to an organization you love.
  11. Estate Planning Savings: As I mentioned above there are all kinds of ways to save your beneficiaries some serious time and money if you plan ahead for final expenses and the tax implications.

As you can see there are some real tax advantages of gifting life insurance proceeds to charity. Heck, it even feels good too! Just remember though, you have to do your due diligence and make sure you do it right. It’s probably a good idea to consult a tax attorney and your accountant. Either way, it’s a fantastic way to leave a legacy and make a real difference!