Charities Collecting Death Benefits: The Life Insurance Loophole

Life insurance is a way to provide financial security for your family, but it can also be used to meet charitable objectives. Charities can be the beneficiaries of a life insurance policy, and there are several ways to donate a life insurance policy to a charity. The simplest way is to name a charity as the beneficiary of your life insurance policy, which will provide the charity with the death benefit proceeds from the policy. Alternatively, you can transfer ownership of an existing policy to a charity, which gives the organisation immediate control of the contract. Another option is to purchase a new policy and designate the charity as the owner and beneficiary. Finally, you can gift the dividends from a life insurance policy to a charity.

Naming a charity as a beneficiary

Donors who are unsure about how they want to distribute their assets after death can list a charity as a revocable beneficiary. This allows flexibility in case their financial situation changes. If the donor decides to stop paying the premiums, the charitable organisation can choose to continue the process or allow the policy to lapse.

If you have an existing policy, it is easy to change the beneficiary to a charity. You will likely need to provide the Tax ID number of the organisation. Also, be sure to let the charity know that it is a beneficiary so that it can contact the insurance company to collect its payout when you die.

If you are applying for a new policy and want to name a non-profit as the beneficiary, the process can be a little more complicated. There may be an "insurable interest" question, which asks the applicant to justify the financial loss the beneficiary would suffer if the insured died. Since some companies can be restrictive about allowing a charity to be a beneficiary, this could impact your ability to get the policy.

Pros and cons

For the owner

• You still own the policy, which gives you access to any cash value accumulation while you are alive and the option to change the beneficiary if you wish.
• You can take a tax deduction if you remain the payor but are no longer the owner of the policy.
• The policy could be counted in the owner's estate for when it comes to paying estate taxes.
• The decision to transfer ownership is irrevocable.

For the charity

• The charity receives a lump sum payment from the death benefit.
• The owner maintains the right to change the beneficiary at any time, so the charity cannot rely on receiving the payout.
• The charity now controls the contract, which means it can name itself the beneficiary or cash out the policy.
• In some cases, the charity takes over the premium payment, which can be a burden on the charity's operating budget.

Gifting an existing policy

Gifting an existing life insurance policy to a charity is a great way to make a charitable donation. This can be done in several ways, each with unique advantages. Here is a detailed guide on gifting an existing policy:

Naming a Charity as Beneficiary

One simple way to provide a charity with death benefits from your life insurance policy is by naming the charity as the beneficiary. This method allows you to maintain ownership of the policy while still benefiting the charity. You can change the beneficiary of an existing policy to a charity by providing the Tax ID number of the organisation. It is important to inform the charity so that they are aware of their status as a beneficiary. This ensures that they can contact the insurance company to collect the payout when the time comes.

While this method doesn't offer income tax advantages, it does reduce the donor's estate by the amount of the death benefit. It also provides flexibility, as donors can list a charity as a revocable beneficiary, allowing them to make changes if their financial situation changes. Additionally, naming a charity as a beneficiary ensures privacy, which may be important for donors who wish to keep their gifting intentions confidential.

Transfer Ownership of a Policy to a Charity

Another option is to transfer ownership of an existing policy to a charity, giving them immediate control of the contract. The charity can then name itself as the beneficiary and receive a tax-free payout when the insured passes away. If the policy has cash value, such as in whole life insurance, the charity can choose to surrender the policy for immediate cash value instead of waiting until the death of the insured.

Transferring ownership has several advantages. The donor can take an immediate charitable contribution tax deduction and, if they continue paying premiums, can take additional tax deductions. Additionally, the policy is removed from the donor's estate for estate tax purposes. However, it is important to note that this decision is irrevocable, and the donor cannot change their mind once the transfer is made.

Gifting Policy Dividends

If you want to receive a charitable contribution tax deduction but are not ready to transfer ownership of your policy, you can choose to gift policy dividends. This option allows you to maintain ownership of your policy while still making a charitable contribution. The dividends donated are deductible in the same way as premiums paid, and it doesn't require any additional cash outlay from the donor.

Donating life insurance can provide benefits to both the donor and the charity. It may reduce the donor's taxable estate, resulting in significant savings on estate taxes for upper-income taxpayers. Additionally, the charity will receive the full amount of the policy upon the death of the insured, which can be a substantial windfall. There are no limits on the size of the policy that can be donated, as charitable donations have no ceiling for estate tax purposes.

By gifting a life insurance policy, donors can leave a lasting legacy for a cause they believe in while also maximising their charitable impact.

Purchasing a new policy

If you don't have an existing life insurance policy, you can consider buying a completely new one and designating a charity as the owner and beneficiary. This strategy typically involves a limited payment policy, where premiums are paid for a set period. The insurer may limit the amount of insurance based on the donor's giving history or charitable obligations.

You can make annual cash contributions so that the charity can pay the premiums. As a donor, you will usually be entitled to an income tax deduction for any such contributions, subject to IRS limits. The charity can use the cash contributions or other funds to pay premiums on the policy.

It's important to note that the tax consequences of donating a life insurance policy can vary depending on the method used. Additionally, the insurance company may require that you have a history of giving to a particular charity to donate your life insurance policy to them.

Before purchasing a new policy, it is recommended to consult a financial professional and tax advisor to explore the best options for your specific situation. Charities may also have different preferences and priorities for how they want to receive and use donations, so it is advisable to consult with them as well when drawing up a plan.

Annual gifts through a life insurance policy

Naming a Charity as a Beneficiary

One way to make annual gifts through a life insurance policy is to name a charity as the beneficiary of the policy. This method allows the donor to retain control of the policy during their lifetime. The charity will receive the death benefit proceeds from the policy upon the insured's death. The donor can choose the percentage of the payout that the charity will receive and can also list the charity as a revocable beneficiary, allowing for flexibility if their financial situation changes. While this method doesn't offer income tax advantages, it does reduce the donor's estate by the amount of the death benefit. It also ensures privacy, as the transaction is kept confidential from family members or other heirs.

Transferring Ownership of a Policy to a Charity

Another approach is to transfer ownership of the life insurance policy to the charity. This gives the charity immediate control of the contract and the ability to name itself as the beneficiary. If the policy has cash value, such as in the case of whole life insurance, the charity can choose to surrender the policy for the cash value at any time, even before the death of the insured. The donor can take advantage of charitable contribution tax deductions by transferring ownership and continuing to pay the premiums. However, it's important to note that this decision is usually irrevocable, and the donor will no longer have control over the contract.

Gifting Policy Dividends

Donors who want to receive a charitable contribution tax deduction but prefer to maintain ownership of their life insurance policy can consider gifting policy dividends. The current year's dividend and any accumulated dividends can be directed to a charity, providing a tax deduction for the donor up to taxable income limits. While this option may not provide as significant a benefit to the charity as the previous methods, it still allows for annual gifts without requiring additional cash outlay from the donor.

When considering annual gifts through a life insurance policy, it's important to consult with a tax professional or financial planner to ensure compliance with tax laws and to maximize the benefits of the donation. Additionally, donors should communicate with the chosen charity to ensure that their gift will be accepted and utilized in the intended manner.

Gifting policy dividends

> "If there is a pool of prior dividends built up in the contract, the owner can gift those as well to a charity and get a tax deduction for that amount—up to tax income limits," says Jon Voegele, former chair of insurance education resource for Life Happens.

Benefits of gifting policy dividends

For the owner:

• You can take a tax deduction for donating life insurance dividends.
• You also maintain ownership of your policy.

For the charity:

It gets a cash contribution without waiting for the death of the insured or having to potentially pay premiums for a transferred policy.

Limitations of gifting policy dividends

For the owner:

The dividend pool is usually tied to the death benefit. If the pool is donated, the death benefit is reduced.

For the charity:

Insurance policy dividends aren't guaranteed and can vary from year to year. Your ability to give might be limited if you don't get a policy dividend, and the charity might not be able to count on your contribution each year.

Frequently asked questions