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You can't take it with you: Giving your life insurance to charity

Is it ever a good idea to sign your life insurance policy over to a charity? Depends on your motives. Depends on the policy. Depends on the charity.

While many people donate entirely for altruistic reasons, it is true that charitable donations are tax deductible. If that's one of your motives for signing away the benefits of your life insurance policy, you should first confirm a few things.

In order to take a deduction, you will have to make the charity both the owner and the beneficiary of your policy.

First of all, ascertain that the organization actually has nonprofit status — that it's a 501(c)(3) organization. Then talk to someone at the organization to make sure it will accept your life insurance policy proceeds as a gift (some charities find they're more trouble than they're worth).

In order to take a deduction, you will have to make the charity both the owner (in states where allowed) and the beneficiary of your policy. If you name the charity as your policy's beneficiary but not the owner, then the IRS won't let you deduct the donation of your life insurance proceeds from your taxes.

Do you donate a term or whole life policy? Term life insurance policies cost the least, but they're also the least attractive to charities. Once the term expires on that policy, it's worthless. Whole life policies cost more, but they have a cash value that builds up the longer you pay premiums on them. Thus, a whole life policy has some intrinsic value to it, although cash surrender value is usually far less than the death benefit amount.

If you donate a term life policy to a charity, you can deduct the cost of the premiums from your taxes. If you donate a whole life policy, you can deduct the cash value of the policy as well as the cost of the subsequent premiums.

Those who might not want your life insurance

According to folks who work in university development offices, most charities would rather be able to make use of a donation right away. Assuming that your goal is to fund scholarships and educate, then a life insurance policy is not going to immediately serve that purpose.

Larger organizations, such as major universities, have their own teams of money managers — people whose sole purpose is to make the school's money grow. It may be that such an organization's endowment fund might be better off investing the money you spend on premiums. Insurance companies are in the business of making money. The money they earn from these policies is money the charity could be using instead.

Here's an example: One large school accepts — but immediately cancels and cashes in — a whole life policy on a 41-year-old male donor. The policy had a $350,000 death benefit and a $20,000 cash surrender value. Assuming the insured lives 38 more years, that $20,000 must earn 7.8 percent a year to grow to match the death benefit value of $350,000. But that same $20,000, invested in the stock market at an average annual return of 10.43 percent annually (the average annual rate of return of the Standard & Poor's 500 from January 1926 to December 2007), will grow to $867,638 over the same time period (minus capital gains taxes).

By canceling the policy and keeping and investing the cash value, the school will come out ahead. That analysis also leaves out the immediate utility value to the school of having the cash immediately. Of course, there is no guarantee that past performance will be repeated in the future or that the funds so invested will not decline as a result of poor investment performance.

Think small

So it's clear that larger charities may believe they can put that money to better use by investing it themselves. But smaller, local charities may not have those resources. And those charities are more likely to welcome any kind of contribution you offer. Still, it helps to remember that the death benefit of a life insurance policy won't be available until after you die, and most charities need the money now.

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