During my general planned giving training sessions, I usually include only one or two slides on life insurance.  My main goal on this topic is to get across that there are many, many variables that go into life insurance policies and many versions, and the charity needs its own objective expert to help assess a proposed life insurance gift.  Sorry, but your typical insurance salesman/financial adviser does not always have the charity’s or even his client’s interests as a priority.

Here is the story that inspired this post:

As will typically happen, I got a call/email.  It was about a “paid-up policy” recently established by a donor with the donor as owner and the charity as the named beneficiary.  Now, the donor wants to go ahead and transfer ownership and receive an income tax deduction for the initial “balloon” payment on the policy – presumably the first and last payment on the policy.

Putting aside questions like what type of policy is it (presumably a universal life policy) and whether there is truth that it only needs one payment, this gift scenario shouldn’t be too hard to figure out.  Think again.

To the charity’s credit, this gift was set up without their knowledge.  Because, if they had come to the charity first and asked me how to do this in the easiest way, I would have said that the policy should be owned initially by the charity and the donor would make a fully tax deductible contribution that would cover the one time premium.  Easy, no appraisals or concerns about how to value, etc..

But, now we have a problem.  Instead of a straight forward gift of cash that will be used to pay the premium,we have a gift that requires a qualified appraisal.  Generally, the deduction for a gift of a paid up or partially paid up life insurance policy is the LESSOR of the cost basis (premiums paid) or the cash surrender value.

Yikes.  Let’s say this is a $1 million life insurance policy with a one-time premium of $300,000.  I don’t know the cash surrender value but I am sure that with the insurance saleman making a nice commission on that initial premium, it will be a lot less than $300,000.  Turns out that an appraiser gave us a rough estimate of a deduction of around $240,000 in this case.  That is $60,000 in deduction lost because an unknowledgeable insurance agent didn’t know what he was doing.  Probably worth $20,000 or more in real cash to this donor.

Second major challenge with this scenario is the qualified appraisal.  Gifts to charity of $5,000 and up of other than cash or marketable securities require a qualified appraisal.  Too much to cover in a blog post but needless to say a major hassle and the greatest potential point of problems for donors.  To complicate matters here, we need to find someone who specializes in appraisals for charitable deduction purposes of life insurance policies (as opposed to ones done for estate planning purposes which have different requirements and different goals).

In this case, the charity had the name of a firm that specializes in insurance gifts, their appraisals, etc… Very fortunate and hopefully the behind the scenes mess won’t reach the donor and dampen their good feelings about the very generous gift that was made.

Part 2 on this post will be after the appraisal is done and will review how the deduction was calculated.  I made it sound very simple but if you look into the topic, you will find various versions of approaches.