Like many individuals, you may own one or more life insurance policies that are no longer needed for family protection, estate expenses or tax-shelter purposes and are paid up or have accumulated significant cash value. You can convert these latent assets into support for Wharton and a stream of payments for yourself or others. A life insurance policy can either be transferred to Wharton or surrendered with the cash proceeds donated as a charitable gift for a gift annuity. The gift annuity will benefit Wharton and provide you with guaranteed payments for life.
When a person transfers a life insurance policy as a charitable gift, the amount of his or her tax deductible contribution is generally the lesser of: (1) the value of the policy; or (2) the donor’s basis (i.e., the net premiums paid) in the policy. In addition, the owner/donor may surrender the policy and then contribute the cash proceeds.
For example, let’s say John Smith, age 72, would like to contribute a paid-up life insurance policy that he owns in exchange for a charitable gift annuity. The face value of the policy is $250,000, the cash value is $90,000 and the cost basis is $50,000. The gift is made on July 1, 2012.
Example 1
Mr. Smith transfers ownership of the policy to Penn:
• Annual full-year payments to him for life (*5.4% x $90,000) = $4,860
• Income tax deduction = $19,349
• Taxation of payments during life expectancy:
Ordinary income (including taxable gain
of $90,000 – $50,000 reported ratably) = $2,746
Tax-free return of capital = $2,114
• Taxable gain at the time of the transfer = $0
Example 2
Mr. Smith surrenders the policy and then contributes the cash to Penn:
• Annual full-year payments to him for life (*5.4% x $90,000) = $4,860
• Income tax deduction = $34,828
• Taxation of payments during life expectancy:
Ordinary income = $1,055
Tax-free return of capital = $3,805
• Taxable gain (taxable as ordinary income) from
surrender of the policy ($90,000 – $50,000) = $40,000
*5.4% is the annuity rate for a 72-year-old individual, fixed for life.
Note that Example 1 avoids recognition of the taxable gain in the policy in the year of the gift; however, a larger portion of the annuity payments are made up of ordinary income in Example 1 than in Example 2.
In certain cases, if some level of insurance is still desired, a lower face amount policy or term policy could be purchased using a portion of the annuity payment for the premium.
These examples have been simplified for illustration purposes. For further information or a custom illustration based on your age, please contact me by phone at (215) 746-6962 or by email at grege@upenn.edu, or link to the Wharton gift planning website at http://wharton.upenn.planyourlegacy.org/. On the topic menu on the left side of the page, click on “Gift Calculator,” which enables you to run a gift annuity illustration, including the charitable deduction and annuity rate, based on your age(s) and gift amounts.
Editor’s note: The article and examples are for information and illustration purposes only and are not intended as legal, financial or tax advice. We encourage you to consult your own advisor.
