Case Studies and Articles

Uses and Misuses of Life Insurance in a Planned Giving Program

Uses and Misuses of Life Insurance in a Planned Giving Program


The old adage, “you should never look a gift horse in the mouth”, may not hold true with gifts of life insurance because so few nonprofit organizations really understand it as a risk management tool and not as an investment.  While nothing should be easier than making a beneficiary designation change to make sure an insurance settlement passes in whole or part to a charity, few donors make those simple choices.  Why not?  Their advisors don’t suggest it as a planning option, donors don’t realize that insurance proceeds can be split up among many beneficiaries and changing a revocable beneficiary designation generates no income tax deduction.


I have a client who wanted to name a large university foundation as the beneficiary of his insurance policy and he asked me to get the T.I.N. and proper name of the organization so I could finish off the beneficiary designation form.  Simple, yes?  No, the university’s planned giving officer proceeded to tell me that the university would only accept it if the policy named them as owner and irrevocable beneficiary of the contract.  I tried to explain that the client only wanted to name the foundation as a beneficiary and wasn’t looking for a tax deduction, but she wouldn’t back off her need for all of the paperwork, so when I reported back to the client, he said, “forget it”.  Why shouldn’t a charity gratefully accept a donor’s offer to name it as either a primary or successor beneficiary?  It could be the development office is more concerned with “booking the gift” rather than listening to what the donor wanted to accomplish. On the other hand, charities have been burned by over-aggressive agents touting insurance as a way to build an endowment if the charity will just let the insurance sales team solicit their best donors.  The common result is that dollars the charity needs today are redirected into commissionable products with less immediate value that are often dumped on the charity’s doorstep when the donor loses interest in this new endowment plan.  As a result, many charities don’t want to have anything to do with either insurance products or insurance producers and that’s a shame because insurance and annuity beneficiary designations are perhaps the easiest deferred gifts to solicit since the products are so often found in donor’s hands.


The use of life insurance in charitable giving makes perfect sense for a number of donor situations. 

1.  Those supporters whom the charity has come to depend on for support and guidance, much like a key-employee in a commercial enterprise, may use an insurance contract to guarantee ongoing financial support for a specific project of importance to the donor.  By leveraging small amounts of annual premiums, often a larger gift may develop over time.  Is this a cost effective approach?  Maybe, maybe not; what has to be determined is this contract being treated as an “investment” or is it the result of extra money being contributed over and above normal contributions by a donor who fully intends to continue making premium payments.  If it’s treated as an investment then some basic assumptions have to be addressed, as there’s nearly always a point beyond which a tax-exempt charity can more efficiently invest in their endowment fund the same premium dollars and generate a greater impact.  The problem for many insurance agents is they forget that the wealth building tax advantages of an insurance wrapped investment won’t apply to an already tax-exempt 501(c)3 charity.  Does it make sense to buy a new policy solely for the use of a charity?  Maybe, if there’s a risk that the donor’s services and support would be lost to the charity before typical mortality or before a traditional investment account could build up enough value to sustain itself, but there is a “crossover” where the traditional investment account will eventually outperform the insurance contract.




 $5,000 annual premium paid for 20 years into a VUL insurance policy ($150,000 death benefit for a 65 year old nonsmoker, earning 10% in sub-accounts) as compared to the same $5,000 annually invested into a mutual fund (10% returns) for 20 years. The VUL policy collapses before statistical mortality if the policy doesn’t maintain at least a 10% gross return and if the premiums don’t continue past 20 years.  The cash values available to the charity from the policy if surrendered after 20 years in this hypothetical illustration would be $134,482 as compared to the traditional investment account value of $315,012.  The “crossover” for investment efficiency occurs if the donor doesn’t die prior to year 14, so each case must be evaluated on its individual merits.  Obviously many different kinds of policies exist, but in the interests of simplicity the basic policy vs. investment comparison was made.


While it’s true that a life insurance death benefit passing to charity is like found money, few policies actually perform as illustration projections prepared years ago predict.  Interest rates, crediting levels and mortality expenses change, and this variability isn’t factored in when policies are transferred to charity.  Where’s the problem?  The guaranteed levels of performance are usually considerably less than wildly optimistic projections that many agents used back when interest rates were 10% to 14%.  To that end, annual reviews of a charity’s insurance portfolio should be conducted by an objective analyst to ensure the policies are performing as designed.  If they deviate significantly, then decisions can be made in a timely manner to preserve the value by reducing death benefit or increasing the premium payments or, if the charity chooses to surrender the policy it should be done before the policy has a chance to implode.


2.  Donors who have old policies once acquired for other reasons (e.g., mortgage or debt risks, education for children, survivor income security, veteran’s policies or those provided by employers) may no longer need the coverage and choose to transfer ownership to a nonprofit.  If the donor transfers the ownership of the contract to a nonprofit organization, then besides removing the asset from the donor’s estate, it will often generate an income tax deduction if all of the rights of ownership are completely transferred.  How is the deduction calculated?  Generally, the donor receives a current income tax deduction equal to the lesser of cost basis or fair market value of the policy.


An often unrecognized problem for an asset potentially worth more than $5,000 is the valuation of the policy. Some would argue that the insurance carrier can easily assess and report its value on a form 712, but careful examination of an IRS form 8283 (required if the value is more than $500) would seem to prohibit the agent and insurance carrier, as parties to the transaction, from performing the valuation and thus there may be a real need for an outside appraiser to assign value.


Gift acceptance policies of the charity should address the following issues:

  • Will the organization make ongoing premium payments if the policy underperforms?  Or will the original donor continue to make gifts of cash or better yet appreciated assets in order to meet ongoing premium liabilities?
  • Does the state recognize that the charity has an “insurable interest” in the life of the insured?
  • Should a cash value policy be surrendered or held, and what types of policies should be accepted.
  • How should the policy be booked for campaign purposes?
  • Is there a minimum quality threshold for the carrier’s financial ratings for size and financial strength?
  • Who evaluates the current and ongoing annual policy statements and projections showing “guaranteed and projected performance values”?
  • Define terms that confuse development officers, e.g., is the policy is truly “paid up” or has the premium simply “vanished” only to reappear later?
  • Understand that there are some tax traps if the policy has outstanding loans,
  • Should the charity viaticate its gifted policies?  Will the donor object to an investor having access to his/her medical profiles and be upset with the occasional ghoulish aspects of selling the policy to an investor looking for a quick return on an investment.
  • How do charities track death claims?


3.  Other charitable uses of life insurance offset the gift of assets by replacing the wealth so heirs aren’t unduly affected.  These so called “wealth replacement” policies are very popular when working with large bequests and charitable remainder trusts or gift annuities.  Why shouldn’t the heirs just inherit those assets and skip the insurance policy hassle?  It might be more tax efficient to have heirs receive an asset that always steps up in value at death, unlike receiving annuity payments or retirement plan proceeds which come with an accompanying income tax and artificially inflates the taxable estate of the deceased donor.  If the life insurance is properly structured and held outside of the estate, then the proceeds pass to heirs without income, gift or estate tax liabilities.  With the proposed loss of step-up in basis under EGTRRA 2001 when the estate tax is phased out insurance may be a preferred asset.




A classic use of life insurance would be to fund the needs for wealth replacement in a zero estate tax plan. This client-donor has a $5 million estate composed of an appreciated family business, investments and pension assets.  By passing $2 million to a 7% CRT and concurrently creating an irrevocable life insurance trust (ILIT) to hold a policy designed to replace the contributed assets and place it in a GST exempt trust, the family has the capacity to eliminate gift and estate taxes. The premium payments are often economically funded with the cash flow from the charitable remainder trusts (or occasionally the charitable gift annuity) and the income freed by income tax deductions.  The family is in an improved position by having inherited assets that step up in basis, more liquidity in trusts to provide security and a chance to support family charitable interests through private foundations, donor advised funds and public charities.


Caution is Needed

A number of problems can develop because so few financial advisors understand the nonprofit culture, and because few development officers completely understand how life insurance functions or is marketed or sold.  Charities need to be careful; for example charitable reverse and split dollar concepts may jeopardize their organization’s exempt status.  Charitable split dollar ran afoul of self-dealing, fraud and step transaction rules because the charity was often used as a conduit to pass benefits to noncharitable beneficiaries all the while accepting tax deductible assets to pay the premiums.  The problem from the charity’s perspective was one of strings being attached to these “gifts” that required the exempt organization to direct those contributions to pay the premium.  Clearly this was not a gift that allowed the charity the choice to invest prudently. 


The IRS hammered this form of abuse with rules found in Notice 99-36.  In Notice 2000-24, it provided compliance guidance on the new reporting requirements imposed by the Ticket to Work and Work Incentives Improvement Act of 1999 as it related to charitable split-dollar insurance arrangements.  Congress used this law as signed on December 17, 1999 in HR 1180 to remove CSD as a planning option for charities and insurance producers.  Ignoring these rules subjects the charity to excise taxes and possible loss of exempt organization status.  Other potential abuses include financed insurance where the charity borrows the premium to insure a number of lives or invests its funds in a “dead pool” of a large number of policies with the expectation that someone will die annually and thus provide a return on its investment.  The charity is pushing the ethical and legal envelope by using commissioned agents to sell a gift annuity.  Recent action* by the SEC claiming jurisdiction over the sale ofa CGA may foretell the end of charities who cozy up to financial services professionals.   Although the Philanthropy Protection Act of 1995 seemed to preclude offering a commission for a gift annuity, these aggressive practices have become more common.


How to approach the gift of an insurance policy? When interviewing clients or potential donors, find out what policies are in place and don’t forget those group plans provided by an employer.  Review the ownership and beneficiary designations and oftentimes clients discover ex-spouses or deceased beneficiaries are still listed, so it’s a great opportunity to suggest changes and introduce a charity into the equation.  If they’ll consider naming a charity for 5% of the death benefit, maybe 10% is an option.  If they’ll split the death benefit for 10%, maybe 25% or 50% is possible, and if they’ll consider 50%, maybe they’ll just transfer the ownership of the entire policy by absolutely assigning it and be done with the whole process.  But you won’t know unless you ask, and since few donors appreciate that they can actually split the beneficiary designations, they don’t consider it.



Billions of dollars of life insurance are in force in this country, and frequently these policies are no longer needed for their original purpose.  Charities ought to explore the use of insurance along with other gift options when they discuss philanthropy with their donors.



SECURITIES AND EXCHANGE COMMISSION v. ROBERT R. DILLIE and MID-AMERICA FOUNDATION, INC., Defendants, and MID-AMERICA FINANCIAL GROUP, INC., Relief Defendant (U.S.D.C., District of Arizona,PhoenixDivision, Civil Action No. CV-01-2493-PHX-JAT)


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Vaughn W. Henry

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