Sharpe Advisor Resources
Retirement Planning & Life Insurance
The following information and references to other resources may be beneficial to you and those who assist you in your estate and financial planning.
Gift Vehicles With Beneficiary Forms
Any funds withdrawn during life from an IRA or other tax-favored retirement plan (other than Roth IRAs) will normally be subject to income tax. If a donor is over the age of 59½ and is not subject to taxes on early withdrawals—and donates these funds for charitable use—there is an offsetting charitable income tax deduction for those who itemize deductions; when properly structured, the transaction can be a “wash” for tax purposes. The impact of state tax laws should also be considered where applicable.
When individuals are facing requirements to withdraw funds from an IRA or other tax-favored retirement account in excess of what they currently need to fund living expenses, they may consider making special gifts to fulfill charitable commitments utilizing the withdrawal amounts.
If they have highly appreciated securities, they may wish to use the securities to fund their gifts, while using cash from the withdrawal to make new investments at a higher cost basis for tax purposes.
As part of the Pension Protection Act of 2006 (PPA), Congress enacted a number of charitable giving incentives and reforms. When gifts from retirement accounts are concerned, the PPA made an exception to the law outlined above and provided in section 408(d)(8) that individuals aged 70½ or older could direct a total of up to $100,000 per year for distribution from their traditional IRA or Roth IRA directly to an organization described in section 170(b)(1)(A) (other than an organization described in section 509(a)(3)) or a donor-advised fund (as defined in section 4966(d)(2)).
After a number of temporary extensions of the IRA giving provisions of the PPA, Congress made the advantages of giving through IRAs permanent in legislation enacted in 2015.
To qualify for gifts from an IRA the qualified charitable distribution (QCD) must be made by the IRA trustee to the charitable recipient and must be otherwise fully deductible.
Amounts transferred in this manner are not included in a taxpayer’s AGI but can qualify as all or part of a mandatory withdrawal. This offers special advantages for donors who otherwise exceed 60% of AGI limits on their gifts or do not itemize their charitable gifts or other deductible expenses. Giving in this way can also prevent other adverse tax consequences such as increased taxation of social security income. The IRA qualified charitable distribution is subtracted from the retirement plan distribution as a “QCD” on the individual’s IRS form 1040 for the year of the gift.
For a complete explanation of giving directly from IRAs, see the Joint Committee on Taxation explanation of H.R.4 at www.jct.gov. See JCX-38-06 (August 3, 2006) publication.
In December of 2022, measures to expand qualified charitable distributions were included in a massive omnibus budget bill. The SECURE 2.0 Act of 2022 contained numerous provisions related to retirement plans and also modified and expanded IRA QCD transfers by indexing the $100,000 per year amount for annual inflation and allowing a one-time election for qualified distributions to charitable gift annuities and charitable remainder trusts of up to $50,000.
Making Testamentary Gifts From Retirement Accounts
From a tax planning perspective, one of the most efficient ways to leave a gift to a charitable interest at death may be through a traditional IRA or other qualified retirement plan.
Simplified example: Joan, a wealthy widow, age 75, plans to leave her $100,000 IRA to her granddaughter, Ellen. An IRA balance as well as other qualified retirement plans may be subject to estate taxes (at an assumed rate of 40%) and income taxes (at an assumed rate of 37%). State income and estate taxes may also be due on these amounts. Under these assumptions, therefore, Ellen could eventually receive less than half of the IRA balance.
Why are these funds subject to both estate and income taxes? Because qualified retirement fund balances are considered income in respect of a decedent (IRD) under Internal Revenue Code section 691. (Note that section 691(c) provides for an income tax deduction for estate tax attributable to IRD.)
Joan, on the other hand, could leave the $100,000 in the IRA directly to one or more charitable interests free from all income and estate taxes. There would be no federal estate tax because of the estate tax charitable deduction and no income tax because of the charitable organization’s exemption from income taxes.
If Joan wished to leave bequests to both Ellen and her charitable interest(s), it would be better for Ellen to receive assets other than the IRA balance. This way, Ellen’s inheritance would possibly be subject to estate tax, but not income tax. If no estate tax were due, Ellen would receive the entire $100,000. Even if Joan were not subject to federal estate tax, the income tax due could reduce the net receipts by up to 37%!
Providing for charity: The term “designated beneficiary” is a technical term that primarily includes individuals. An irrevocable trust that meets certain requirements can also be a designated beneficiary. Although a charity can be a beneficiary, it cannot be a designated beneficiary. Neither can a charitable remainder trust (CRT). Nor can any of multiple beneficiaries if any one of them is a charity or a CRT.
If, however, the plan owner names both a charity (or a CRT) and an individual as beneficiaries and the distribution to the charity (or CRT) is made before the date for determining whether there is a designated beneficiary, the individual beneficiary will be considered a designated beneficiary.
Spousal rollover: If the surviving spouse of an IRA owner receives a lump-sum distribution from the IRA, the surviving spouse generally may roll the distribution over into his or her own IRA tax free within 60 days of receipt.
If a spouse rolls funds to their own IRA, it could then be wise for the spouse to leave all or a portion of any amounts remaining at death to a qualified charity on a tax-free basis.
Qualified Terminable Interest Property (QTIP) trust: It is possible, subject to certain requirements, to make the QTIP election with respect to both an IRA and a trust named as beneficiary of the IRA. See Rev. Rul. 2006-26. In this case, it may be desirable to provide that part or all of any principal remaining in the trust at the surviving spouse’s death go to charity.
Rollover to charitable trusts: As of January 2023, federal tax law, under the SECURE 2.0 Act, provides for a special one-time election to make a qualified charitable distribution (QCD) from an IRA of up to $50,000 to a charitable remainder trust.
Designating a charitable remainder trust as beneficiary: It is possible to name a CRT to receive the balance of an IRA at death. In this case, the money is not subject to income tax on the transfer from the IRA to the CRT because of the CRT’s tax exemption under Code section 664(c). The individual beneficiary of the CRT simply pays income tax on the distributions he or she receives from the trust.
Upon the transfer from the IRA to the CRT, an estate tax charitable deduction is allowed for the value of the remainder interest in the trust as determined under IRS regulations. When IRA assets are left at death to a CRT, a question arises: What becomes of the income tax deduction under Code section 691(c) for estate tax attributable to income in respect of a decedent (IRD)?
In Letter Ruling 199901023, the IRS said the deduction was allocated to the CRT and was used to reduce the amount of first-tier income (ordinary income) for trust income tax accounting purposes.
With increased estate tax exemptions enacted as part of the Tax Cuts and Jobs Act of 2017, planning for estate tax consequences of establishing a CRT at death will be less of a consideration for many. However, the passage of the Setting Every Community Up for Retirement Enhancement Act of 2019 (SECURE Act) may lead to increased interest in funding CRTs for loved ones with retirement plan assets. Additionally, the SECURE 2.0 Act provisions providing for a one-time election for IRA QCDs of up to $50,000 to split-interest gifts for donors and spouses provide another life income tax-favored option for those with an IRA.
Donors and advisors should always check the latest statutes and regulations prior to completing gifts in this manner.
Other relevant rulings: In Letter Ruling 9237020, the IRS considered a proposal to leave residual IRA money at the IRA owner’s death to a charitable remainder unitrust, which would make payments to the IRA owner’s child for a term of 20 years and then distribute all of its assets to charity. The IRS ruled that the IRA money would not be subject to income tax as it rolled out of the IRA into the unitrust because of the trust’s exemption from income taxes under IRC section 664(c). The IRS also ruled that the IRA money rolling into the unitrust would qualify under the usual rules for the federal estate tax charitable deduction.
In Letter Ruling 9253055, the IRS took the same basic position with respect to a proposal to leave, at death, residual money in a corporate retirement plan account to a unitrust for the benefit of the donor/employee’s spouse. This ruling stated that the spouse’s interest in the unitrust would qualify for the federal estate tax marital deduction.
This type of plan can make sense for the charitably motivated person who (1) wants to shield residual IRA or other retirement plan money from what may seem to be punitive estate and income taxes; (2) wants to provide an income to a family member; and (3) likes the idea of outlining the use of any remaining funds at the termination of the trust.
The Basic Tax Rules
Fair market value: The fair market value of a life insurance policy given to charity is not necessarily the amount the donor can claim as an income tax charitable deduction for the gift, but it is the starting point in determining the donor’s deduction. See Internal Revenue Service Publication 561 (01/2022), Determining the Value of Donated Property.
Internal Revenue Service regulations and court cases establish rules for determining the fair market value of an insurance policy.
In the case of a paid-up policy, the fair market value for federal gift tax purposes is the cost of replacing the policy. See Regulation section 25.2512-6(a), Example (3). One case holds that for federal income tax purposes, however, the fair market value of a paid-up policy given to charity is the policy’s cash surrender value because that is the amount the charity can realize from cashing in the policy. See Tuttle v. U.S., 436 F.2d 69 (2d Cir. 1970).
For a whole life policy on which premiums remain to be paid, the fair market value is the policy’s interpolated terminal reserve value plus the unexpired portion of the last premium paid. The fair market value is (1) increased by the amount, if any, of dividends accrued to the date of gift and (2) decreased by the amount of any outstanding loan against the policy. See Reg. section 25.2512-6(a).
For a term policy, the fair market value is simply the unexpired portion of the last premium paid. See Revenue Ruling 76-490, 1976-2 C.B. 300; Rev. Rul. 79-47, 1979-1 C.B. 312.
The Donor’s Income Tax Charitable Deduction
Ordinary income rule: The income tax charitable deduction for a donation of an insurance policy is limited to whichever is less: the fair market value of the policy or the donor’s basis in the policy. The donor’s basis is equal to the net premiums (gross premiums minus dividends paid back to the donor) paid on the policy. See Internal Revenue Service Publication 526, Charitable Contributions.
In other words, the donor receives no income tax charitable deduction for any appreciation (or inside build-up) in the policy. This is because any appreciation represents unrealized ordinary income as opposed to capital gain. Under Internal Revenue Code section 170(e)(1)(A), no federal income tax charitable deduction is allowed with respect to appreciation that represents unrealized ordinary income (or short-term capital gain).
Planning technique: As such, in some situations the donor may find it advantageous to cash in the policy and then donate all or a portion of the cash received. Although cashing in the policy causes the donor to realize any inside build-up in the policy as ordinary income, it may be possible to offset this income completely with the charitable deduction for the cash donation. See Internal Revenue Service Charitable Contributions – Written Acknowledgments. Whether the donor will obtain a complete offset depends on the percentage limitations applicable to the income tax charitable deduction discussed below.
The result to the donor (assuming a complete offset) will be a net charitable deduction equal to their basis in the policy—the same deduction as would be allowed if the policy itself were donated. Unlike contributing the policy, however, contributing cash will not bring into play the qualified appraisal rules discussed on Page 11.
Percentage limitations on the federal income tax charitable deduction: The federal income tax charitable deduction is subject to various percentage limitations.
The overall ceiling on the deduction is 60% of AGI. Gifts of cash to public charities are deductible up to this 60% limit. See IRC section 170(b)(1)(A).
Gifts to public charities of certain types of appreciated property held long term are generally deductible up to 30% of AGI. See IRC section 170(b)(1)(C).
If the charitable contribution for a gift of an appreciated life insurance policy is reduced to the donor’s adjusted basis in the policy because of inside build-up, the donor’s income tax charitable deduction for the gift is deductible under a higher AGI limitation.
Excess charitable contributions may be carried forward for up to five years. See IRC section 170(b)(1)(B).
Qualified Appraisal Rules
Generally, a qualified appraisal (as that term is defined in Reg. section 1.170A-13(c)) is needed to sustain a claim of an income tax charitable deduction with respect to a donation of non-cash property other than publicly traded securities if the claimed value of the property (or the aggregate claimed value of all gifts of similar property made during the year) exceeds $5,000.
Is a life insurance policy cash or a publicly traded security? It is clear that a life insurance policy is not a publicly traded security. It is also fairly clear that a life insurance policy is not cash because, although it can be reduced to cash by being surrendered, the policy itself is a bundle of rights different from the rights constituting ownership of cash.
Therefore, to protect the tax position of the individual who donates a life insurance policy having a claimed value of more than $5,000, it is essential to obtain a qualified appraisal for the policy.
The income tax regulations provide that a qualified appraisal cannot be prepared by a party to the transaction in which the donor acquired the item to be appraised. See Reg. section 1.170A-13(c)(5)(iv)(B). Neither the insurance agent who sold the policy to the donor nor the issuing company may prepare the appraisal.
The safest course of action in obtaining the appraisal is to have the appraisal prepared by someone competent by reason of training and experience to value an insurance policy who had no connection with the issuance of the policy (e.g., a tax accountant). There is no prohibition, it is worth noting, against the appraiser using information provided by the issuing company to appraise the policy.
In addition to obtaining a qualified appraisal, the donor is required to file an appraisal summary—IRS Form 8283—with their federal income tax return on which the gift is first claimed or reported. See Reg. section 1.170A-13(c)(4). The appraisal summary must be acknowledged (signed) by the donee organization.
If the donee organization, within three years of the date of gift, sells or otherwise disposes of donated property as to which it has signed a Form 8283, it must report the sale to both the IRS and to the donor on IRS Form 8282. See IRC section 6050L.
In order for an appraisal to be a qualified appraisal, it must be obtained no earlier than 60 days before the date of gift and no later than the day before the due date of the income tax return on which the gift is first claimed or reported. Due date includes extensions of time to file the return. See Reg. section 1.170A-13(c)(3)(iv)(B).
Gift of a Policy Subject to a Loan
In general, if an appreciated asset is given to a charitable organization, the donor does not realize the appreciation for federal income tax purposes. The reason is that, generally, gain is realized only if an appreciated asset is sold or exchanged, and a charitable contribution is merely a donative disposition.
If appreciated property subject to a mortgage or other indebtedness is given to charity, however, the transaction is treated as a bargain sale under Reg. section 1.1011-2, and the donor does realize a portion of the appreciation as a capital gain or ordinary income, depending on the type of appreciation involved.
The IRS has taken the position that a donation of a life insurance policy subject to a policy loan is a bargain sale—just as is a donation of mortgaged real estate. In other words, the IRS views the policy loan the same way it views a mortgage. See Revenue Ruling 80-132, 1980-1 C.B. 255.
Bargain sale formula: The amount of gain realized when property subject to debt is given outright to a charitable organization can be determined using this formula:
- Gain Realized = (FMV – B) × (D/FMV)
- “FMV” is the fair market value of the donated property (determined without regard to the debt).
- “B” is the property’s adjusted basis in the donor’s hands.
- “D” is the amount of the mortgage debt or policy loan. See Reg. section 1.1011-2 and Reg. section 1.1011-2(c), Example (4).
Thus, for example, it appears that if a life insurance policy with a fair market value of $10,000, with a $4,000 adjusted basis in the donor’s hands and subject to a $2,000 loan, is given outright to a charitable organization, the donor realizes a gain of ($10,000 – $4,000) × ($2,000/$10,000), or $1,200.
The donor is also entitled to claim a charitable contribution equal to $8,000 – I, where $8,000 represents the donor’s equity in the donated policy, and “I” is the amount of the policy’s appreciation that is allocated to this equity.
The allocation is made on a proportionate basis. “I” is equal to $6,000 (total appreciation) × ($8,000/$10,000), or $4,800.
The donor’s charitable contribution, therefore, is equal to $8,000 – $4,800, or $3,200. Under IRC section 170(e)(1)(A), this reduced contribution may be claimed in an amount up to 60% of the donor’s AGI (with a five-year carryover for any excess contribution), assuming the policy is given to a public charity.
Gift of Group Term Coverage
Generally, an employee must report as income the cost of employer-paid group term life insurance on their life for coverage in excess of $50,000. See IRC section 79(a).
A special rule, however, excuses the cost of employer-paid group term coverage in excess of $50,000 for coverage payable irrevocably to a qualified charitable organization for the entire portion of the taxable year during which such coverage is provided to the employee. See IRC section 79(b)(2)(B).
This basically means that an employee can tack on some additional employer-paid group term coverage for the benefit of their favorite charity at no tax cost to the employee.
Insurable interest issue
In most states, statutes expressly permit a charitable organization to take out an insurance policy on the life of an individual, subject to certain requirements. Be sure to check applicable law for the state in which you live.
There are numerous charitable gift planning techniques involving life insurance. One example is the use of life insurance to replace assets that have been donated either on an outright basis or through other planning techniques.
The so-called wealth replacement plan comes in several varieties. The basic idea of the plan is to make a charitable gift (either outright or via a charitable remainder trust or other life income plan) and use the tax or other financial benefits resulting from the gift to pay for life insurance.
The wealth replacement plan can be an excellent way for a charitably motivated person to make a gift while still providing for loved ones. Keep in mind, however, that purchasing insurance and using it for tax and other financial benefits when making charitable gifts is simply an investment choice on the donor’s part, and that the donor may wish to consider other investment alternatives.
This information is solely educational, namely, to provide general gift, estate, financial planning and related information. It is not intended as legal, accounting or other professional advice, and you should not rely on it as such. For assistance in planning charitable gifts with tax and other implications, the services of appropriate and qualified advisors should be obtained. Consult an attorney for advice if your plans require revision of a will or other legal document. Consult a tax and/or accounting specialist for advice regarding tax and accounting related matters.