Charitable Gifts Using Life Insurance

on ; last featured December 3, 2016

The greatest investments are made in the hearts and lives of people for eternity. These are the investments that keep on giving—sometimes for generations! Now, did you know that your life insurance policy can be used to make an eternal impact in the kingdom of God? You can give the gift of life insurance to a Christian charity or organization and be a partner in accomplishing God’s mission.

One of the primary purposes of life insurance is to provide for family in the event the insured passes away prematurely. Life insurance is often used to protect against the loss of an insured’s income, to provide needed liquidity to an insured’s estate, or to replace an inheritance. Another purpose is to protect a business in the event of the death of a business owner or other individuals who are key to the business’s success. In this context, it is necessary for the business to maintain “key person” insurance so that the business has the necessary cash to engage in a mandatory purchase, or redemption, of company stock from the estate of the insured or to protect against the loss of company income due to the death of a key employee. A mandatory redemption in cases involving closely held businesses is often required by a shareholder agreement signed by each shareholder so as to ensure the continuity of a business after the death of a shareholder.

In addition to its use in estate, business, and financial planning, life insurance can also play an important role in a client’s charitable giving strategy. This article will review some basic information related to life insurance as well as how life insurance can be used in charitable giving.

The Basics: Types of Life Insurance

Term Life Insurance

Under a term life insurance policy, if the insured passes away during the policy term then the death benefit is paid to the policy beneficiaries. If, however, the insured outlives the policy term, then no benefit is paid unless the insured renews the policy and dies during the new term. Most term policies do not have a cash value account, meaning there is no cash accumulation benefit to purchasing a term policy. A term life insurance policy can be established as a group term, annual term, or level term policy. Since there is a possibility that the insured will survive the policy term and allow the policy to lapse, charities typically prefer to receive permanent insurance policies.

Permanent Life Insurance

A permanent insurance policy can be set up as a whole life, universal life, or variable life policy. There are many variations on these three basic permanent life policies. Permanent life insurance policies provide coverage for the insured’s life. They combine the death benefit of term insurance with a cash value account that accumulates value during the insured’s life. The purpose of the cash value account is to reduce the net amount at risk and avoid the higher mortality costs of insurance in the later years of the insured’s life. The cash value will accumulate in different ways depending on the type of permanent insurance policy purchased. Among other strategies, a policyholder may take out a loan against any accumulated cash value or use the cash value to pay policy premiums.

Whole Life Policies

There are a number of whole life policy variations including limited pay contracts, graded and modified premium life policies, single premium policies, and interest-sensitive whole life policies. However, the most common type is “ordinary” or “traditional” whole life insurance.

Under an ordinary whole life policy, the premium is fixed for the insured’s life. The insurer must pay the death benefit regardless of its actual investment or claims experience. To offset the risk of poor investment performance or a large number of claims, the insurer sets premiums for ordinary whole life policies based on very conservative investment and mortality assumptions and liberal expense assumptions. As a result, ordinary whole life policies are the most expensive permanent life insurance policies on the market.

Universal Life Policies

In a universal life policy the insurer guarantees the death benefit as long as there is enough in the cash value account to pay monthly mortality and expense charges. This gives policyholders flexibility in determining the timing of premium payments. As a result, the investment risk and the risk of selecting the product premium level are borne by the policyholder instead of the insurer (as is the case with an ordinary whole life policy). Since the policyholder bears increased risk, universal life policies are typically less expensive than ordinary whole life policies.

A universal life policy typically has a cash value account and a cash surrender value account. Premium payments are made and premium taxes and expenses for distribution and underwriting are deducted. The leftover premium goes to the cash value account. From there, monthly mortality and expense charges are subtracted and interest is credited to the account. Finally, a surrender charge is deducted from the cash value account before the cash surrender value is determined. The surrender charge typically continues for 10 to 20 years before phasing out. If the policyholder surrenders the policy, the insurer will pay the cash surrender value.

Variable Life Policies

In a variable life insurance policy the policyholder is responsible for investing the policy’s cash value in an array of subaccounts. A variable life policy can be set up as either a variable whole life or a variable universal life policy. Of the two, universal life is the most popular because it offers the policyholder flexibility over the timing of premium payments.

Single and Joint Life Policies

Term and permanent insurance policies can be established as a single life insurance policy. A single life insurance policy insures one life and pays a death benefit when that person passes away. Single life policies are often used to provide for a survivor, to provide liquidity in an estate or, in the business setting, to insure the life of a key employee or stockholder.

On the other hand, a joint life policy or second-to-die policy insures two lives and pays a death benefit when the survivor passes away. Most second-to-die policies are permanent insurance policies since insuring two lives is generally a long-term proposition. Second-to-die policies have lower premiums than single life insurance policies since the addition of a second life expectancy pushes out the projected death benefit payment. Second-to-die policies are often used to provide liquidity in an estate or to provide an inheritance.

How to Give the Gift of Life Insurance

Many life insurance products exist that will provide financial security, liquidity, diversification, or an inheritance. However, if a policyholder’s circumstances change, he or she may consider surrendering or otherwise disposing of the policy. For individuals with charitable intent, making a gift of the insurance policy may be a great opportunity to provide for a cherished cause.

Charitable Deduction and Gift Substantiation

Life insurance is an ordinary income asset. Therefore, an outright gift of an insurance policy will generate a charitable deduction for the lesser of the policy’s value or the policyholder’s basis in the policy. The policyholder can take this deduction up to 50% of his or her adjusted gross income (AGI) in the year of the gift and carry forward any unused deduction for up to five additional years.

How to Give a Life Insurance Policy Outright

There are several ways to donate a life insurance policy outright to charity. Each strategy has unique tax consequences.

Donor Transfers Ownership During Life

a. Paid-Up Policy

A paid-up life insurance policy is a policy where all premium payments are complete and the policy will stay intact until the insured’s death or termination of the policy. If an individual makes a gift of a paid-up life insurance policy he or she will receive a deduction equal to the lesser of the policy’s fair market value or cost basis. No future premium payments need be made, so the charity can either surrender the policy and receive the cash surrender value or hold the policy until the insured passes away in order to receive the full death benefit.

b. Policy that Requires Future Premium Payments

A policyholder can transfer ownership of an existing policy to charity that requires future premium payments. Once the charity is owner and beneficiary of the policy, it has no obligation to maintain the policy. Therefore, the charity could simply surrender the policy. However, if requested by the donor, many charities will maintain the policy as long as the donor continues to pay the premiums.

A policy donor has two options when making premium payments on a policy owned by charity. First, the donor may make contributions to the charity with the understanding that the charity will pay the insurance company or may make the premium payments directly to the insurance company. A policy donor who makes contributions to charity is entitled to a deduction for the fair market value of the contribution up to 50% of AGI in the year of the gift.

Second, a policy donor may want to ensure contributions are being used to pay life insurance premiums. These donors may choose to make premium payments directly to the insurance company. A policy donor who makes premium payments directly to the insurance company is entitled to a deduction for the amount of the premium payment made and may deduct this payment up to 30% of AGI in the year of the gift. The payment directly to the insurance company is considered a payment “for the use of” and not “to” the charity. Therefore, the 30% deduction limitation applies.

c. Donating a Policy with a Loan

In general, transferring ownership of a life insurance policy to charity is not a taxable event. As mentioned above, a policyholder can take out a loan against the cash value of a permanent insurance policy. If an insurance policy with an outstanding loan is contributed outright to charity, the contribution is treated as a bargain sale. In other words, the gift will be treated as though the donor made a gift of the value of the policy and received in return the value of the loan.

The policy donor’s basis will be allocated between the amount of the gift and the amount received. The deduction is the lesser of the policy’s fair market value minus the loan or the donor’s basis allocated to the gift. The donor must recognize ordinary income in the amount of the loan minus the basis allocated to the amount received.

Donor Designates Charity as Policy Beneficiary or Contingent Beneficiary

Clients who would like to donate a life insurance policy, but want to maintain control of the policy during life, may designate a charity as beneficiary or contingent beneficiary of the policy. Naming a charity as designated beneficiary or contingent beneficiary does not entitle the policyholder to a charitable income tax deduction. In general, there must be an irrevocable transfer of the policy to charity before an income tax deduction will be allowed. When a policyholder merely designates charity as the designated beneficiary, there is no irrevocable transfer since the policyholder has maintained ownership of the policy and may change the designated beneficiary at any time. There is no charitable deduction even if the policyholder makes the beneficiary designation irrevocable because to take a deduction in this circumstance would run afoul of the partial interest rules. Upon the policyholder’s death, his or her estate will be entitled to an estate tax deduction for the amount transferred to charity.

Use Policy Dividends

If the client owns a policy that pays out cash dividends, then the client may make annual cash gifts to charity using these dividends. This will generate a charitable deduction that the donor can take up to 50% of AGI.

Dividends can also be used to purchase additional insurance. A donor could use policy dividends to purchase additional insurance and name the charity as owner and beneficiary of the policy. This would generate a charitable deduction for the lesser of the policy’s fair market value or the client’s cost basis in the policy.

Planned Gifts with Life Insurance

In addition to generating a charitable deduction, you may desire increased income. Planned gifts offer the opportunity to turn a future death benefit into current income. In addition, life insurance may be used as part of a charitable giving strategy that replaces amounts given to charity in the donor’s estate.

If state law allows a charity to own life insurance, then life insurance may be used to fund a charitable gift annuity (CGA) or a charitable remainder trust (CRT). The primary question under state law is whether the state considers the charity to have an insurable interest in the donor. Most states have now adopted legislation providing that charities have an insurable interest in policies owned on the lives of donors. However, it is good practice to research what the law says in your particular state.

Wealth Replacement

A donor may desire to make a charitable gift, but may not have the resources to make a substantial gift and still provide for heirs. In this situation, life insurance can be a great way to replace the amount in the client’s estate used to make a gift to charity.

Investing in God’s Kingdom

Life insurance is a very flexible financial product. It can be used to accomplish various estate and financial planning goals. Consequently, many US households have some form of life insurance. As circumstances change, policyholders may no longer need coverage. This can be a great opportunity to incorporate life insurance into a client’s charitable giving strategy. A policyholder has many options when making a charitable gift including making an outright gift, funding a planned gift, or setting up a wealth replacement strategy. Each option should be considered and the appropriate one selected based on your client’s estate, financial, and charitable goals.

For Christians, as long as your household is cared for (1 Timothy 5:8), life insurance can be a great way of investing in God’s kingdom by giving to a Christian charity or organization. When you give, you become a partner in sharing the good news of the gospel and reaching out to others. What a legacy to leave for future generations!


Get the latest answers emailed to you or sign up for our free print newsletter.

I agree to the current Privacy Policy.

Answers in Genesis is an apologetics ministry, dedicated to helping Christians defend their faith and proclaim the gospel of Jesus Christ.

Learn more

  • Customer Service 800.778.3390