Life insurance policyholders know the importance of naming a beneficiary on their plan. The beneficiary or beneficiaries will receive the death benefit when the policyholder passes away. While people commonly purchase life insurance to leave a legacy for their family, they can also use their policy to leave a major charitable donation behind.
Many people aspire to give more to charity during their lifetime but are unable to find the funds. Life insurance policyholders can turn their death benefit into the ultimate act of altruism. Read on to learn how to give your policy to charity and how funds are awarded when the time comes.
Table of Contents
- What Types of Life Insurance Can Be Used for Charitable Giving?
- Giving Through Life Insurance vs. Cash Donation
- Factors to Consider When Selecting a Life Insurance Policy for Charitable Giving
- 4 Ways to Donate Your Life Insurance
- How to Choose a Charity
- Understanding the Tax Implications of Donating Your Life Insurance
- Putting it Together
What Types of Life Insurance Can Be Used for Charitable Giving?
All types of life insurance policies fall under one of two primary categories: term life or whole life. Term life insurance covers a set term, usually between 10 and 30 years, and only pays the death benefit if the policyholder dies within that period of time. Term life does not accrue a cash value but is ideal for policyholders seeking affordable monthly premium payments.
By contrast, whole life insurance lasts for a lifetime as long as premiums are paid. Whole life insurance policies also include a cash value component, which allocates a portion of the premiums paid toward a tax-free savings account that adds to the death benefit. While either type of life insurance can be gifted to charity, whole life is ideal for its added cash value. However, it’s worth noting that whole life insurance policies typically cost more each month and necessitate a longer application process than a term policy.
You should also check with your chosen charity to determine their preferred way of handling a life insurance donation. Some charities will not accept being named as beneficiary on a term life policy, only on whole life insurance policies.
Giving Through Life Insurance vs. Cash Donation
Giving to charity through your life insurance policy is a good option for many, but cash donations are always welcome, too. Before you decide how to give, explore the benefits of giving through life insurance.
- Larger Contribution: By nature, life insurance policies are exponentially greater in value than a single cash donation. Giving the entire death benefit of a life insurance policy to charity is a larger donation than most people can make while they are alive.
- Affordability: Paying premiums into a life insurance policy can allow policyholders to grow the size of their charitable gift beyond their own individual means. The amount of your monthly premium is likely much more affordable as a piecemeal expense than a lump-sum donation to a charitable organization.
- Potential Tax Benefits: Life insurance death benefits are generally not subject to income or estate tax. Aside from enjoying a tax-free death benefit, policyholders who choose to donate their life insurance to charity before they die can claim a tax deduction for the amount of the policy.
- Potential Growth: Whole life insurance policies with a cash value savings option can grow your death benefit over time. The longer whole life policies are open to accrue cash value, the higher the potential gift for charity when the policy pays out.
While making a charitable contribution through life insurance has its advantages, a cash donation may better suit individuals who prefer a more straightforward and private process or are looking to make an immediate impact. Consider which method of giving works for your own individual circumstances.
Factors to Consider When Selecting a Life Insurance Policy for Charitable Giving
You can maximize the impact of your gift by carefully selecting the right policy. Consider the following key factors:
- Policy Type: Generally, you should strive for the most coverage, based realistically on what your budget will allow, whether through a term life or whole life plan. Some people prefer the lower premiums offered by term life plans, while others need the cash value of a whole life policy.
- Coverage Amount: Deciding how much coverage you need depends on your intentions for the death benefit. If your plans include making a charitable donation and leaving additional funds to beneficiaries, be sure to calculate enough for expenses such as covering debts, income replacement, and college funds.
- Charitable Beneficiary Designation: All insurance policies need at least one named beneficiary to ensure the funds can be distributed smoothly, according to the donor’s wishes. While most policies allow it, some have limits or guidelines around naming a charitable organization as beneficiary. Always consult your individual insurer to confirm.
- Flexibility: Policyholders’ needs often change over time. You may eventually decide to add or remove a charity as your named beneficiary, so enrolling in a policy flexible enough to accommodate your priorities as they evolve, is key.
- Tax Implications: Life insurance policies often attract buyers for their tax-free coverage. Policyholders do not have to pay taxes on their policy, and beneficiaries do not owe taxes on the payout they will eventually receive. Should you decide to donate your life insurance policy or its dividends to charity before it pays out, you can claim a tax deduction for that amount.
Experts recommend reviewing your charitable donation plan with a trusted source or financial advisor to ensure your policy is carried out according to your wishes.
4 Ways to Donate Your Life Insurance
You can give the charitable gift of life insurance in a variety of ways. The following are just some of the most common options for donating your life insurance policy.
Name the Charity as Your Beneficiary
Most insurance policies allow you to simply name a charity or charities as beneficiaries. This may especially appeal to policyholders with multiple life insurance policies, each with different beneficiaries. The downside for the charity is they must wait til your policy pays out; however, the upside for you is you can maintain management of your policy in case your needs change.
Transfer the Policy Ownership to a Charity
You may decide to transfer ownership of your policy while you are still alive, before your policy would naturally pay out the death benefit to charity. This option carries multiple benefits for both parties: the charity receives the gift sooner than a traditional payout, and you can claim a tax deduction for the premiums paid and the total coverage amount.
Gift Dividends to a Charity
Whole life insurance policies with an accrued cash value may also yield dividend earnings. You can choose to donate these dividends to charity while still reserving the rest of your benefits for your family or other beneficiaries. This option is ideal for policyholders with enough cash value to make a charitable gift and also provide for their loved ones with a traditional death benefit.
Add a Charitable Giving Rider
You may purchase a charitable rider for your policy for an additional cost, provided the charity you choose is an IRS-qualifying nonprofit 501c3 organization. As an add-on feature, a charitable giving rider requires the insurer to pay an additional award to a charity of your choice when you die, separate from your death benefit. Most policies that offer this option, if at all, require expensive premiums and high cash value.
How to Choose a Charity
Despite some for-profit groups that solicit donations, a charity must be a nonprofit organization or 501(c)(3) as recognized by the IRS to accept your life insurance benefits. You can search the IRS database online to make sure the charitable organization of your choice appears on its list.
Consider donating to an organization whose mission and values are aligned with yours, where your gift can make a significant impact. The IRS only qualifies select types of nonprofits to receive legacy donations including religious organizations, libraries and art museums, educational organizations, public charities, and private foundations.
It’s a good idea to let your chosen charity know of your plans so they can be sure to follow up on the future death benefit claim when the time comes.
Understanding the Tax Implications of Donating Your Life Insurance
Donating your life insurance to charity offers different tax benefits depending on when you make your gift. Your accumulated premiums and death benefit are not taxable, though any interest accrued on top of your cash value in a whole life account may be taxable upon payout. Should your needs change, you can cash it out to keep the funds tax-free or let the funds go to charity — also tax-free — when you pass away.
You may enjoy additional tax advantages if you transfer your policy to a charity before death. By transferring ownership to a charitable organization prior to paying out your death benefit, you can take a tax deduction of the policy value and premiums paid for that year, deduct future premium payments, and keep some of the proceeds from the accrued cash value of your account, all while still making a sizeable donation.
Putting it Together
Donating your life insurance policy to charity leaves a lasting legacy of philanthropy. Anyone can choose to name a charity as beneficiary or even give their policy to charity before they die. Even a portion of a donor’s policy, such as the dividends earned on their whole life plan, can make a world of difference for a nonprofit organization.
Gifting some or all of your policy to a charitable organization offers unique tax benefits, including tax-free giving and potential deductions for the total amount of the policy. Donors can also use one of several policies or give a partial gift while keeping the remaining death benefit in place for their loved ones. Most insurers offer multiple options for donating life insurance benefits.