How to Use Life Insurance to Donate to Charity

When most of us buy life insurance, we're thinking about one thing: Making sure our families are taken care of after we're gone. But in this season of giving, you might also want to think about setting up a policy to take care of your favorite charity.

It's a method of giving that can benefit both parties.

What's in it for you? Properly structured, life insurance policies allow money to grow tax free, and the death benefit is usually transferred to the beneficiary tax free. While the proceeds will be included in your gross estate, your estate will receive a charitable deduction for the amount of the proceeds upon your death, explains Robert DiQuollo, a certified financial planner and CEO of Brinton Eaton, a wealth advisory firm.

If you own a policy, you may also assign the ownership from yourself to the charity. If you live more three years past the date you reassign the policy, the proceeds will not be included in your gross estate.

Why make the transfer while you're still alive and kicking? Because when you transfer the insurance contract to the charity, you get an income tax deduction in the year you hand it over. How big a break depends on the type of life insurance policy you offer up.

A Tax-Free Path to Bigger Donations

To get a sense of how it can work, let's take this hypothetical example: Say a 58-year-old with a $10 million estate wants to give a big donation to her favorite charity. She could simply donate half of the estate -- $5 million -- directly. Or, she could buy a $10 million life insurance policy with an increasing death benefit at a cost of $718,000 per year for seven years, approximately the same roughly $5 million cost. If the value of the life insurance policy grows at 7.5% over a 30-year-period, explains Jeffry Weinhuff, CEO of Swift Estate Capital, the charity would receive almost $27 million upon her death, a generous gift indeed.

Another example is a wealthy individual who plans to both give large amounts of money to charity at their death and also purchase life insurance to provide for their heirs. That person might leave their entire estate to charity - thus eliminating all estate taxes -- while their life insurance death benefit would pass tax free to their heirs.

Then too, you could also get a charitable giving rider for a life insurance policy with a face value of more than $1 million. This is an attractive option because you don't pay extra for the rider, and usually there is no increase in the premium or reduction in the cash value of the death benefit.

Charity Could Insure You

But giving to charity via life insurance isn't just for rich folks.

"A policy gift to a charity can be extremely powerful, allowing ordinary people to make much larger contributions to their favorite charity than outright cash or even appreciated property," says Dwight Raiford, a senior financial planner with MetLife Financial Group.

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Another option: Have your charity of choice take out an insurance policy on you. Then, each year, you make a gift of the premium amount to the charity, which uses those funds to pay for the policy. The charity receives the insurance proceeds when you die, and when you make those annual donations of the premium, you get the income tax deduction. This sidesteps the issue of the three-year look-back period one faces when transferring a policy: You never owned it, so it won't be included in your estate.

"Say you have a $100,000 policy and a $1,000 premium. For $1,000 you can step up to the plate and get a lot of bang for your buck," says Susan Bruno, a certified public accountant and private wealth specialist with Beacon Wealth Advisors. "It's a way to give without coming up with a lot of money."

The advantages of giving this are significant. "Donations grow each year; you can initially put out less funds; [funds accrue] tax free, which [they] cannot do in your estate; and life insurance may be financed, but your other donations are made in cash," points out Weinhuff.

The Reality Check

Your heart may say to give -- but what does your head say?

The first step should be determining your estate planning needs. Make sure your plan meets your current financial needs, provides properly for your heirs, and also the charity.

Be aware that you'll need to qualify for an adequate amount of life insurance, which you may divide between your heirs and the charity. The qualification process will include both medical and financial underwriting. Realize too, that insurance is not available in unlimited amounts.

Also, recognize that the type of life insurance you chose is important. Term insurance ends at the conclusion of the term it's purchased for, so if a donor lives past the term, the charity you pick as a beneficiary receives nothing. Permanent policies, such as whole life or variable universal life, while more expensive, may be better options for this type of giving, suggests Raiford.

Finally, before you give up ownership of a policy, be sure you've checked out the organization, and that you're certain about the decision. It's an irrevocable transfer.