The other day, a client walked into our office looking for something a bit different than what you might expect. He wasn’t worried about providing for heirs. He wanted to fulfill a philanthropic vision.
In fact, we have a lot of clients who are passionate about many charitable causes, and they come to us because they want to give in perpetuity. In these cases, we often recommend using life insurance as a means of funding a private family foundation. Not only does this offer some tax benefits, but it can also allow our clients to give significantly more than they would have with a simple donation.
What Is a Private Family Foundation?
A private family foundation is an organization that is established as a nonprofit entity or a trust. It needs to be created with charitable intent. This means you can’t use it to benefit a specific individual, but instead must use it to bolster a cause. However, the list of causes you can give to is quite extensive and includes:
- Religious entities
- Educational organizations
- Scientific research and development
- Literary and arts organizations
- Testing for public safety
- Fostering for amateur sports competitions
- Organizations that support individuals in need
- Animal rights entities
To establish the foundation, you’ll need to develop the foundation’s guidelines for giving and its criteria for awarding grants. The foundation can be one that’s established as its own nonprofit entity or as a trust. The nonprofit entity is often more popular because it provides more legal protection for decision-makers, though the trust is far less complex. Generally, the more you give and the more people involved, the more you should lean toward creating a nonprofit over a trust. By law, the private family foundation must donate at least 5% of its assets to keep its tax-exempt status on a yearly basis.
You’ll need to designate a trustee or board of directors to manage the foundation’s giving after your death. One benefit of creating a private family foundation is that you can also provide future employment to heirs. The foundation allows you to assign beneficiaries as employees of that foundation, meaning they’re allowed to draw a salary from the private family foundation as a reasonable related expense. It can be a good way to encourage your heirs to get involved with your legacy of giving.
While it’s common to fund a private family foundation with appreciated assets like property, an alternative is to fund it with life insurance policies. This method allows you to give a gift to a charity that can be worth several times more than it’s value when you pass away. In addition, you can take a tax write-off for it now.
The Tax Benefits of a Private Family Foundation Now and In the Future
The ideal way to contribute life insurance to a private family foundation is to give the funds directly to the foundation, which will then purchase a policy on your life. By the foundation owning the policies and paying the premiums, you avoid any incidents of ownership.
In addition, the amount you give to the private family foundation doesn’t affect the $15,000 annual gift tax exclusion or the current $11.2 million gift tax exclusion. This can be a good way to reduce the size of your estate because every dollar you gift to the private family foundation is removed entirely from your estate with no impact on your gift tax exclusion. Finally, you can take a tax deduction for it now. The cost of the premium is the basis for your deduction and you’re permitted to take the deduction for up to 30% of your adjusted gross income.
You can also use this as a place to put highly appreciating assets. For example, if you donate a property to the private family foundation, you can remove it from your estate. Then, if the foundation decides to sell the property, they can do so without having to pay any capital gains tax because of their tax-exempt status.
Now, while this might sound like the ideal way to give into perpetuity, you do need to consider some of the drawbacks of the private family foundation. In some cases, it might be a bit too complex to manage and there can be more than a few pitfalls involved.
The Drawbacks of the Private Family Foundation
Private family foundations are much more complex to manage than standard irrevocable life insurance trusts (ILIT) because of their tax-exempt status. As such, you’re going to need the assistance of a qualified legal advisor to create one. In addition, once it’s set up, you’ll want to be as hands-off as possible.
This is because you must avoid any incidents of ownership on the life insurance policies used to fund it. If you’re on the board of directors for the foundation, and the foundation owns the policies, then you may be found to have incidents of ownership. This means that policy could potentially be added to your estate when you pass away.
Next, you need to avoid any indication of self-dealing. Self-dealing is when the primary contributor to an organization — in this case you — appears to be receiving goods or services from that organization, and the contribution is considered taxable. So for example, you could not donate a policy to the foundation and then take a loan on that policy from the foundation.
Finally, if you’re giving money, you cannot demand that the money is used to fund life insurance policies or pay premiums. While that might be the goal of the gift, you need to remember that to avoid incidents of ownership, your gift needs to be just that — an irrevocable gift that the foundation can use to raise money for the cause.
While this might sound complex, using life insurance in conjunction with a private family foundation can still be an excellent way to enhance your giving to a cause. If you have the right advisors, this should be a process that can allow you to get valuable tax breaks while also creating a legacy of giving. For more information on using life insurance to fund a private family foundation, contact a Howard Kaye advisor at 800-DIE-RICH.
