On the Record: Taking Out Life Insurance on Your Donors: A Gamble?

In the past few years, there have been numerous issues concerning the details of how a charity should benefit from a donor’s life insurance policy. A new life insurance-based plan provides a benefit to charities in the form of cash payment or significant future income — without the charity being required to invest any money.

Such plans need to be carefully evaluated by charities because they raise a significant number of tax issues. This column serves as a brief outline of the plan and the issues that should be considered by a charitable organization before going forward.

The way it works
Basically, a charity asks a pool of individuals to agree to permit an insurance policy to be purchased on their lives. The individual, in effect, donates his “insurability” to charity. The funds needed by the charity to pay the annual insurance premiums can be provided in a number of ways. The payments can be borrowed from the insurance company, affiliate or an investor pool expressly established for this purpose — or provided via the charity’s purchase of a single premium annuity on the individual.

If an annuity is purchased, the annual annuity income is used to pay the annual premium on the life insurance policy. This structure is financially beneficial to the charity as long as:

• the annual annuity payments are sufficient to pay the annual life insurance premium; and

• the death benefit from the life insurance policy exceeds the amount of the initial single premium for the annuity and the other costs not covered by the annuity payments, such as the first premium payment on the life insurance policy.

If there is borrowing on the charitable organization’s behalf, the policy serves as collateral for the loan. The individuals who agree to be insured do not provide funds toward the purchase of the policy, nor do they receive charitable deductions for their participation. Their only contribution is their insurability. The advantage for them is knowing that an organization they care about will benefit.