The Tax Cuts and Jobs Act’s dramatic expansion of the unified credit from federal estate taxes with a sunset provision could reverberate in the philanthropic and life insurance worlds as well.
First a quick review. The Act would double the basic exclusion amount from $5 million to $10 million, which will also be indexed for inflation, effective for tax years beginning after Dec. 31, 2017. The estate and generation-skipping transfer tax would be repealed for decedents after Dec. 31, 2023. Step-up in basis to fair market value at death would be retained.
Life Insurance Strategies
A life insurance program can meet the needs of both the sophisticated donor and the charity. It will likely continue to be appealing to more modestly affluent donors not subject to the federal estate tax. The transfer of a wholly paid-up policy during lifetime or payment of premiums on a policy now owned by a charity generates an income tax deduction, after all.
From the donor’s perspective, there’s certainty of result: the face amount of the policy will be paid to advance a charitable goal. Relying on specific assets or a percentage of the residue at death may or may not meet the donor’s target. The donor also retains access during lifetime to all its assets to weather the vagaries of financial markets or the uncertainties of its financial situation. Should unexpected healthcare expenses or the need to support family members arise, the donor has those assets available.
However, in light of the proposed changes, advisors to the wealthy will be evaluating whether it makes financial sense to fund a life insurance program for a tax that might never need to be paid or a tax dramatically less than what was initially envisioned during planning. Some very likely will maintain their insurance programs. Specifically, owners of closely held business enterprises are still facing the need for liquidity to buy out the interests of a deceased owner to avoid dealing with the heirs. Even for ultra-high-net-worth, savvy investors, life insurance can be attractive. Many consistently earn returns greater than a charity’s endowment spending rate. They’re open to contributing every year the amount that would have been paid by the endowment and then endowing the fund at their death with life insurance.
But likely, some may wish to contribute life insurance policies to charity, feeling confident enough about the diminished or eliminated need for life insurance.
Now’s the time for charities to begin reviewing their gift acceptance policies on how they decide to accept gifts of life insurance.
Useful Questions
Here are some useful questions that should be raised with any charitable gift of life insurance.
- What’s the purpose of the policy? The case didn’t discuss the foundation’s purpose in entering the life insurance arrangement. Was the life insurance “an alternative investment” on a donor of impaired health? Was it part of a program initiated by the insured? Of course, all would be appropriate purposes. But, an upfront clear statement of purpose should be put forth between both the insured and the charitable beneficiary.
- Will the transferring owner of an existing policy continue to contribute premiums if the premiums are needed? The foundation wasn’t prepared to make any more payments; How would the insured likely react to this discontinuance?
- Who within the charity is monitoring on an annual basis the performance of the policy? An environment of unusually low interest rates requires a policy to be systematically reviewed, ideally at least annually.
- If the charity is unwilling to pay additional premiums, what is it prepared to do? Continue the payments for a smaller face amount? Exchange with the insurance company? Sell to a third party?
This is an adapted version of the author’s original article in the December 2017 issue of Trusts & Estates.