Innovative Strategies to Enhance Charitable Giving
Jerry Borrowman, MSFS, CLU®, ChFC®, CAP®, LUTCF
Jerry Borrowman, MSFS, CLU®, ChFC®, CAP®, LUTCF Director of Advanced Markets for the Penn Mutual Life Insurance Company at Cambridge Financial Center in Salt Lake City, Jerry is also a member of The American College Alumni Association Advisory Board of Directors.
The classes I took live at The American College to qualify for the Chartered Advisor in Philanthropy (CAP®) designation are among the most meaningful of my career because of the potential to use life insurance products to help worthy causes. Plus, charitable giving devices can often reduce a family’s estate tax burden with tax-favored replacement of donated values to heirs using life insurance. I find philanthropy to be an intriguing and exciting aspect of our business. Returning home, I made an effort to reach out to charities to share ideas on how to build their endowments only to find that many charities are unaware of the power of life insurance and annuities to help them achieve their goals. In some cases fund-raising professionals are even suspicious of our motives and worried that planned gifts will reduce much needed current gifts. Since those early days I have moderated my approach to first provide basic training to key individuals at the charities on how life insurance and annuities can help build the endowment while providing excellent planning opportunities for clients. Because of that I have been invited to speak at conferences in several states on “10 Innovative Strategies to Enhance Charitable Giving.” It is gratifying to hear the “a-ha” moments in the group as individual fund-raising professionals, attorneys and accountants catch the vision of what we can do to help their best donors and clients. Two of those strategies strongly illustrate the flexibility of life insurance as part of the planning process.
Let me start by saying that these ideas will only have traction with well-established charities that have a dependable current cash flow that provides for their staff and charitable needs. Planned giving means that the benefit of the gift will often be received at a future date, most often to help build an endowment fund. Charities must be patient when courting large gifts to fund these programs, so it’s important that you acknowledge to your key contacts at the charity that you are aware of their current needs for donations, and that the ideas you share will supplement what their donors are already doing rather than replace it.
USING LIFE INSURANCE TO MAGNIFY A CHARITABLE GIFT
Life insurance may provide a charity with a dependable rate of return on donated funds that mature as a death benefit. You should be aware of two tax regimes in considering this strategy:
1. Charity owns the policy: A client donates money to the charity, which then pays the premium on a policy owned by the charity on the life of the donor. This provides a current tax deduction to the client, but he or she has no ownership rights in the policy. The charity is the beneficiary and has access to policy cash values during the life of the donor. Some practitioners suggest that the charity should take partial withdrawals or dividend surrenders, not policy loans, as policy loans may create Unrelated Business Taxable Income (UBTI), which creates unnecessary taxable income. State insurable interest laws may restrict a charity’s ability to make the initial purchase of life insurance on the life of a donor. In that case most practitioners feel that it is appropriate to have the individual apply for the policy on his or her own life and, once in place, donate the policy to the charity, because insurable interest applies only at the time of application.
2. Client retains ownership: In this case, the client names the charity as the beneficiary and does not receive a current tax deduction because the policy owner retains all interests in the policy, including the right to change the beneficiary. At death the proceeds will be paid directly to the charity free of both estate and income taxes (because of the unlimited charitable deduction available to estates). This strategy allows the policy owner to retain access to policy cash values just in case he or she needs them, but to benefit a charity at death.
Giving a charity an interest in a life insurance policy is a generous act on the donor’s part. In some cases the rate of return on policy values may be so attractive to a charity that it wishes to add additional funding to the policy beyond that contributed by the donor whose life is insured. As long as the charity has permission to do so from the donor, this is a generally accepted practice. This may be a great way for the charity to increase the return on its money, particularly in the current environment of low interest rates on certificates of deposit and other fixed income accounts. Consider annual premiums and single premium life insurance policies using whole life and guaranteed no-lapse universal life policies.
For example, suppose a 60-year-old male client wishes to provide a $1 million endowment to his alma mater at death. He can do this a number of ways using life insurance:
• $31,471 equals annual premium for whole life insurance. In this case the initial death benefit of $1 million grows to $1,649,584 at age 85 and the cash value grows to $651,000 (based on 2011 dividend scale, which is not guaranteed. This provides an annual internal rate of return of approximately 3.5 percent on cash value and 5 percent on death benefit at life expectancy), which is very favorable in today’s market. The charity has use of policy cash values as needed.
• $14,304 equals annual payment needed to guarantee a no-lapse universal life policy. This contract builds nominal cash value, but the internal rate of return (IRR) on death benefit is very positive.
• $8,879 equals annual payment needed to guarantee a no-lapse survivorship index universal life policy assuming a spouse of age 60. Again, cash value build is nominal ($270,844 at age 85, decreasing thereafter), but if held to the joint life expectancy, the IRR on death benefit is more than 7 percent guaranteed. That’s a remarkable benefit in today’s economic climate.
Think of it this way: A client is able to donate $8,879 per year to a favored charity. Certainly the charity will be grateful, but they’re not likely to name a building after him. But that same tax-deductible $8,879 used to pay the premium on a survivorship policy is guaranteed to result in a $1 million endowment. Not only will that provide great recognition for the donor’s family, but it also will provide an ongoing stream of income to the charity in perpetuity, if desired. That’s the power of life insurance to help a charity build its endowment program.
But it’s not the only way. A charity may wish to acquire life insurance on the life of a well-established donor whose death would adversely affect the charity—most likely a member of the Board of Directors or fundraising committee. If the charity has the means, it could acquire $1 million of protection on the same 60-year-old male using a single premium policy:
• $470,000 is the single premium needed to fully fund a whole life policy. This creates an immediate death benefit of $1,004,581 and an end-of-year cash value of $447,849. The cash value at the end of year two is $474,673, more than the initial premium. If held to life expectancy at age 85 the cash value would grow to $1,684,344 at the 2011 nonguaranteed dividend scale, and the death benefit would more than double to $2,007,917. Even at a zero dividend rate, the guaranteed cash value would grow to $804,993 with a death benefit of $1,004,581. The IRR on this approach currently exceeds 5 percent by year 10, demonstrating a favorable way to reposition charity assets to increase rate of return while providing a death benefit.
• $219,169 is the single premium cost of providing $1 million of guaranteed no-lapse universal life.
• $160,439 is the single premium needed to fully fund a guaranteed no-lapse index survivorship universal life. This provides an IRR in excess of 7 percent per year guaranteed. The $160,439 is guaranteed to mature for $1 million with no market risk.
As you can see, life insurance may be a great way for a charity and its donors to provide guaranteed returns on their assets.
USING SPIA/LIFE TO PROVIDE INCREASED CURRENT INCOME
How do you provide a 75-year-old with 6.1 percent income guaranteed for life? You do it using this strategy, which also may be used by a charity to increase the real return on its existing cash assets. This is an idea I learned about from John Homer, CLU®, ChFC®, a great local agent who is a leader in MDRT, as well as an advocate for advanced training in the industry. John has used this idea to provide enhanced cash flow to his clients, as well as to help charities realize a much greater return on their existing assets. He wrote an article for another publication entitled “The Perfect Storm for Charities.” As you may know from watching the movie or reading the book The Perfect Storm, there must be three conditions for a perfect storm to form (the kind that has incredible force of unusual magnitude). In the case of the charitable perfect storm, the three elements are: 1) reduced contributions, particularly from wealthy donors; 2) increased demand on charities because of lost jobs; 3) lower return on existing assets because of the historic low interest rates being paid on certificates of deposit and other interest bearing accounts.
How can financial services professionals help? Consider two products sold by insurance companies: life insurance and life income immediate annuities. Used in combination they can provide some great benefits. Consider an example:
A 75-year-old male in excellent physical condition purchases a single premium immediate annuity (SPIA) with no refund from Insurance Company A. The current payout is $103,000 per year guaranteed for life (10.3 percent of the original premium). This same client goes to Insurance Company B and applies for a $1 million guaranteed no-lapse universal life policy. He is approved at an annual premium of $42,000. The difference between these two numbers ($103,000 - $42,000) is $61,000 per year. In other words, the client has taken a $1 million asset that may be earning 1 percent to 2 percent in a certificate of deposit and replaced it with a guaranteed net lifetime income of $61,000 while his heirs or charity will receive $1 million income tax-free from the life policy at his death. That’s the same as providing 6.1 percent income for life. And, once approved, it is risk free (benefits are paid based on the financial strength of the life insurance companies that issue the annuity and life insurance policy).
ANNUITY PAYOUT VERSUS LIFE INSURANCE PREMIUM
Here is a table of sample values. This table assumes an insurable client who purchases a guaranteed no-lapse universal life policy from a $135 billion highly rated mutual insurance company, as well as an annuity from a second carrier. Rates are based on November 2010. Actual rates and payout will depend on the medical insurability of the client/donor, payout rates in effect at time of purchase and companies selected.
| Age at Issue | Annuity Payout* | Insurance Premium** | Free Cash Flow*** |
|---|---|---|---|
| 55 | 6.5% | 1.3% | 5.2% |
| 60 | 7.0% | 1.7% | 5.3% |
| 70 | 8.8% | 3.0% | 5.8% |
| 75 | 10.3% | 4.2% | 6.1% |
| 80 | 12.5% | 6.5% | 6.0% |
* - Annuity Payout Rate is shown as a percentage of premium paid
** - Insurance Premium is shown as a percentage of face amount, Male Select-Preferred Non-Tobacco
*** - Free Cash Flow shows the annuity payout minus life insurance premium
As you can see, this presents a great opportunity in the right circumstance, but there are limitations. For example, once the strategy is initiated there is no cash available except for the annual net income, because 100 percent of the premium used to purchase the life income immediate annuity is nonrefundable. This means the charity must be able to function with annual income for an unknown period of time without access to the original principal for the annuity. At the death of the key person the charity will receive an amount equal to its original annuity purchase payment by virtue of the guaranteed death benefit. Plus, this will only work when the charity has an established relationship with an individual who is both willing to allow the charity to own life insurance on his or her life and whose medical insurability will provide the needed spread to make the strategy meaningful. The IRS takes a dim view of charitable stranger-initiated life insurance because the investors wind up with the greatest economic benefit. Therefore, the charity should use existing funds, not borrowed or investor monies as, in this strategy, the charity gets 100 percent of the benefit.
Hopefully, you can see that there are many noncharitable applications for this strategy, including lifetime income for a widow, reducing the value of an otherwise taxable asset to zero when owned in the estate (because the life income immediate annuity has zero value at death) with asset replacement to heirs in a policy owned outside the taxable estate, and so on. But it has unique application for charities that have an existing endowment fund who desire to increase the guaranteed rate of return they earn on assets during the life of a selected donor or key employee.
I’ve touched on just a couple of the available options, but what I hope you get from this brief discussion is the important partnership role that we as financial services professionals can play in the estate planning/charitable giving arena. We offer the products that enable the use of planned gifts because we can provide for all parties at the table—charity, grantor and heirs.
