Term Conversion Legacy Plan

Typically, there are two ways to donate.

The most common way to gift a policy is by simply assigning the charity as the beneficiary, and upon death, the estate would receive a tax credit based on the amount of the gift. The second method is to change both the policy ownership and beneficiary to the charity.

Clients wanting to go that route should consult the charity beforehand to be certain they accept a gift by this method.

If your clients donate policies at fair market value, make sure they can use the full donation tax credit, since they can only deduct up to 75% of net income each year while alive and can only carry the credit forward for five years.

The donor receives a charitable tax credit for the policy’s FMV, which is often far greater than the cash surrender value. But who pays the premium once the policy is donated? If the insured continues to pay premiums, the insured will receive additional tax credits for the premiums paid. If not, the premiums can be deducted from the policy’s cash value, or other donors to the charity can pay the premiums. When the insured dies, the charity will

receive a death benefit from the insurer that is usually significantly larger than the initial value of the policy and the premiums.

Case Study

Let’s take a look at John, a 71-year-old non-smoker who recently suffered a heart attack. John purchased a $500,000 Term 10 policy in 2008. Both the cash surrender value (CSV) and the adjusted cost basis (ACB) is zero. After consulting with an underwriter and actuary,

John is deemed uninsurable with a rating of 500% (i.e., his premiums would be 500% higher than normal).

Taking these and other factors into account, the actuary establishes that the FMV of John’s policy is $225,000—a substantial increase compared to a CSV of zero. John has a dilemma. To maintain coverage, he must convert the policy to permanent before age 75; otherwise, the term will expire, leaving the policy worthless. Converting to permanent insurance will result in annual premiums of about $21,000 per year, and John is unsure if he can commit to this for life.

There is a third option: gifting the policy to a charity.

If John were to gift his policy, he would receive a tax credit of $225,000 for the FMV of the donation; this credit can then be applied to reduce his net taxable income this year, or carried forward up to five years. Working with an experienced actuary and underwriter is key. An underwriter assesses the mortality risk and life expectancy of the insured person. In conjunction with an actuary, the key features of the life insurance policy are examined to determine the FMV, such as death benefit, cost of insurance, mortality risk, replacement cost, cash value, policy loans, conversion options, riders and other privileges.

Once a valuation has been acquired, the next step is to obtain the support of the charity. They must be first willing to take on the gift, and if the donor does not wish to continue paying the premiums going forward, they will need to find someone else who will. This can take time. And, not all policies are of interest to charities. Cases that make the most sense are typically ones where the clients are approaching 70 or are older, or have had a serious health issue. It just so happens that those tend to be the policies with the biggest fair market values.

Other Considerations

Not all life insurance policies are held personally. A policy that is corporately owned may also be a good fit for donation. This can be particularly true for contracts trapped inside a company; situations like this may arise when a company is sold, reorganized or wound up, and taxation makes it costly to transfer a corporately owned policy to a shareholder or another entity. Surrendering the policy is commonly thought of as the only viable option when tax liabilities make other planning strategies prohibitive, but a policy donation can provide a viable way out with an attractive tax credit.