Life insurance as a charitable gift

Why do people donate to charity? Some do it for religious reasons. Others want to give back to organizations or programs that have helped them in the past. No matter the reason, it's clear that charitable giving makes people feel good and is on the rise. According to the National Philanthropic Trust, Americans gave $484.85 billion to charities in 2021 — a 4% increase in donations from 2020.

When it comes to giving back, most of us think about pulling out our checkbooks. But donating life insurance allows you to make a sustainable gift without having to write that large check. And if you do want to write one, the death benefit from your life insurance can increase the size of your donation.

Why donate life insurance?

Besides leaving a lasting legacy that supports a cause you care about, there are several reasons to consider donating life insurance to charity.

For one, there are potential tax benefits. Additionally, donating life insurance may help reduce your taxable estate while preserving other assets for your beneficiaries.

How does donating life insurance work?

To understand how donating life insurance works, it helps to know the roles people and entities can play in a life insurance policy:

1. The owner or policyholder of the life insurance contract has the decision-making rights for all the other roles. This person can cancel or change the contract, as well as execute riders and benefits. The owner or policyholder is usually the person insured by the policy but not always. The owner can also be a nonnatural person, like an entity.
2. The insured is a person covered by the life insurance policy. In case of the insured's death, the death benefit is paid to the named beneficiaries. The insured is usually the owner of the policy but not always.
3. The beneficiary receives the death benefit when the insured dies. Beneficiaries can also be entities. This is the case in a charity donation.
4. The payer handles paying the premiums to keep the policy active. The payer doesn't have to be the owner, the insured or the beneficiary. And in the case of a charitable donation, it's important to understanding who's responsible for paying the premiums.

Most types of life insurance policies can be donated to a charity or nonprofit organization, including term, whole life and universal life insurance. But because permanent insurance is designed to last a lifetime, this is the preferred type.

Note: This doesn't have to be an existing policy. Someone may want to apply for a new life insurance policy to leave a legacy to a cause they care about. Before you apply for coverage, connect with the charity to discuss the donation and to make sure they can accept the gift.

If you decide to donate life insurance, there are several ways to go about it.

Name a charity as the beneficiary

The simplest way of donating life insurance to a charity is to name the charity as a beneficiary. This means they will receive the allotted death benefit when the person insured by the policy dies.

If you aren't completely sure how you want to distribute the proceeds, naming the charity as a revocable beneficiary may be useful because you're able to change your mind in the future. For example, maybe another charity comes along that becomes equally as important to you. You're allowed to give 50% of the death benefit to Charity A and the other 50% to Charity B. Or maybe someone comes into your life that you'd prefer to name as your beneficiary. By maintaining ownership, you're able to keep control.

In this instance, not only does the donor continue ownership, but they also usually continue paying the policy premium. Although the premium payments are not considered tax deductible, there can be some estate tax benefits to making this decision. In circumstances where there is an estate or inheritance tax concern, choosing a nonprofit as the beneficiary could help with estate planning.

Here's another benefit to naming a charity as a beneficiary: It keeps the donation private, which can be important to donors who don't want to discuss their gifting intentions with family or other heirs. Distribution of death benefits from an insurance policy cannot be contested, so disgruntled heirs won't be able to stop the donation after you're gone.

Transfer ownership of policy

You can also gift your entire life insurance policy to a cause you care about. For example, if you're enthusiastic about rescuing animals and no longer need a life insurance policy to meet your personal financial needs, you can transfer ownership of the policy to your favorite animal rescue charity.

If you donate the policy, the charity group will receive the full amount of the death benefit, which is typically more than it would receive from, say, a charitable giving rider.

This is usually an easy process, but before you go through with it, ask yourself:

• Am I comfortable relinquishing control of the policy?
• Might my feelings about the organization change someday?
• Who will handle making the premium payments — myself or the charity?

Donating life insurance comes with benefits for you, as well: Some premium payments or existing cash value may qualify for a tax deduction and donating your policy could help lower your taxable estate, which could save big in estate taxes.

Gift policy dividends

If you have a permanent life insurance policy that pays dividends, you can receive those dividends in cash and make a reoccurring cash donation to charity. This can be a great way to support a charitable organization over time without having to donate other assets or transfer the ownership of the policy. But it's worth noting that gifting policy dividends usually won't result in the same amount of benefit to the charity. It can also be irregular, given that dividends can fluctuate and are not guaranteed.

Donated dividends usually are tax-deductible, just like premium payments made on a gifted policy. And as long as the cash from dividends is less than your premium cost basis, you won't face a tax penalty.

What about a charitable giving rider?

Usually for an added cost, charitable giving riders can be attached to life insurance policies to show that a percentage of the policy's value should be paid to a specific charity.

But they do come with a few limitations:

• Generally, there is a maximum allowable gift amount.
• Charities must be qualified 501(c)(3) organizations.
  Some organizations won't accept life insurance policies as donations. Others avoid certain types of policies like term life insurance policies.

Be sure to discuss your options with a licensed tax advisor and your financial advisor. They'll help you understand potential tax issues before you donate life insurance or make other charitable donations.