Business Valuation, Growing Value And Liquidity Realization (Part XVIII Of Book Series)

Gifting Life Insurance

Gifting Life Insurance to Charity Generates Cash

Benefits
Life insurance is an excellent tool for making charitable gifts for a number of reasons.
• Life insurance provides an “amplified” gift that enables you to purchase immortality on an installment plan.
• Through a relatively small annual cost (the premium), a benefit far in excess of what would otherwise be possible can be provided for charity.
• This sizeable gift can be made without impairing or diluting the control of a family business or other investments.
• Assets earmarked for family members can be kept intact.

For example, a 50-year old committed to giving $5,000 annually for 10 years could leverage the $50,000 gift into a $360,000 gift. A second-to-die, or survivor life policy, adds even more leverage. A 50-year old couple could make a gift of $800,000 with the same $5,000 annual commitment. (Assumes 50-year old(s), preferred non-smoker(s) using variable life policy earning 10% gross return.)

Using a traditional permanent life insurance contract will generally yield a 6% to 7% internal rate of return to life expectancy on premiums paid.
Life insurance can be a self-completing gift. For a donor committed to making annual gifts, a portion of the annual gift can be directed to an insurance policy guaranteeing the continuation of that gift in perpetuity. If the donor becomes disabled, the policy can remain in force through the “waiver of premium” feature (if elected). This guarantees the ultimate death benefit to the charity and, in some cases, the same cash values and dividend build-up that would have been earned had disability not occurred. Even if the donor dies after only a few premium payments, the charity is assured a full gift. The death proceeds can be received by the designated charity, free of federal income and estate taxes, probate, and administrative costs, and without any delay, fees, or transfer costs.

These gifts to charity are less subject to attack by heirs because of the contractual nature of the life insurance policy. The death benefit is guaranteed as long as premiums are paid. This means that the charity will receive an amount that is fixed (or perhaps increasing) in value, and not subject to the potential downside of volatile market risks as in securities.

Policy valuations. The gift value of an existing life insurance policy (where premiums are still required) is the lesser of the interpolated terminal reserve (cash value + unearned premiums — loans) or the donor’s adjusted basis. The contribution is generally measured by cash value in the policy’s early years and the donor’s adjusted basis after “crossover” when the cash value is greater than the cumulative premium paid.
2 years of premium $20,000
Cash value $12,000
Charitable Deduction $12,000

Alternatively, he gives the policy to charity and receives a $100,000 deduction (though it has a CASH VALUE of $150,000).
Mr. Donor pays $10,000 annually for 10 years for an insurance policy. $100,000
After 10 years, he has $150,000 CASH VALUE. $150,000
Charitable Deduction $100,000

If the policy is “paid up” (contractually requires no further premiums), then the deduction is the lesser of the adjusted cost basis or the policy’s replacement cost. The insurance company can provide the donor with the proper valuation for any type of permanent policy.

Policy valuation with outstanding loans. The type of gift would be treated as part sale/part gift, i.e., a bargain sale. The donor would incur income tax liability for the ordinary gain (if any) on the sale portion, and would obtain a charitable contribution deduction for the (lesser of) fair market value or adjusted cost basis for the non-sale portion.

For example, Mr. Donor contributes a policy subject to an outstanding loan to his favorite charity.

● On the date of contribution, the policy’s FMV equals $10,000 $10,000 $1,000,000
The donor’s adjusted basis in the policy equals $4,000, and $4,000 $400,000
the outstanding amount of the loan equals $4,000. ($4,000) ($200,000)

● Amount realized equals $4,000 (the outstanding amount of the loan). $4,000 $200,000

● Basis allocated to sale equals $1,600: $4,000 (basis) X [$4,000 (amount realized) ÷ $10,000 (fair market value)]. $1,600 $80,000
`
● Gain recognized equals $2,400: $4,000 (amount realized) – $1,600 (basis allocated to sale). $2,400 $120,000

● Amount eligible for charitable deduction equals $2,400: $4,000 (adjusted basis) – $1,600 (basis allocated to sale). $2,400 $320,000

Note: Under charitable split dollar legislation, if the policy has any outstanding loan at the time of the contribution, the donor will not receive a charitable income tax deduction for the gift or any future premium contributions as it is deemed a private benefit transaction.

The article was provided with permission of the Planned Giving Design Center, LLC. Revised: Michael Brink and Bryan Clontz

Have a question? Contact Michael Gilburd

Michael Gilburd, President of ValuCorp International, Inc., has more than forty years of experience in financial transactional services and corporate development.Founded in 1999 by Mr. Gilburd, ValuCorp is a national firm offering expert business valuation services and consulting of creating, improving and preserving value, capital markets and corporate finance advisory, transaction and fairness opinions, restructuring advisory, and management consulting. While serving many industries, ValuCorp specializes in financial institutions, healthcare companies, manufacturing and distribution, professional service firms, energy companies, construction, real estate ventures, and consumer product companies.

Prior to ValuCorp, Mr. Gilburd was:
• Managing Director of corporate finance for two American Express companies, where he assisted in raising funds for various transactions, including acquisitions and public offerings.
• National Director of Corporate Finance for BDO USA, one of the nation’s largest accounting and consulting firms, and a member of their International Corporate Finance Committee.
• Internal Revenue Agent, Manhattan District, New York

Mr. Gilburd has authored many Business Valuations, Family Limited Partnership Valuations and Loan Packages for private and confidential transactions and settlements.

Subscribe to TaxConnections Blog

Enter your email address to subscribe to this blog and receive notifications of new posts by email.