Make the Most of Your Life Insurance

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.

 

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