Week 7

Question 1

A donor gives all rights in a life insurance policy to a public charity. The donor’s basis in the contract is $10,000. The face amount is $100,000. The fair market value of the policy is $15,000. Which of the following is correct?

A) The donor gets a deduction for the fair market value, up to 50% of AGI.

B) The donor’s deduction is for the basis, up to 50% of AGI.

C) The donor can deduct the fair market value, up to 30% of AGI.

D) The donor can deduct the basis, up to 30% of AGI.

Answer 1

B) The donor’s deduction is for the basis, up to 50% of AGI.

Question 2

All of the following statements concerning the attractiveness of life insurance for the purposes of charitable giving are correct, EXCEPT:

A) The face amount of the life insurance policy paid to the charitable organization will not be subject to federal income taxation or probate costs, even if the donor owns the policy.

B) The transfer of a life insurance policy to a qualifying charitable organization will give the donor significant tax benefits, such as the current available income tax deduction.

C) A person can make a substantial contribution to a qualifying charitable organization without a substantial out-of-pocket cost during life.

D) The premium payments will generally be lower, if a charitable organization is involved in the transaction.

Answer 2

D) The premium payments will generally be lower, if a charitable organization is involved in the transaction.

The premium payments will not be lower. The after-tax cost of the premium may be lower, but the premium will remain the same.

Question 3

IRAs in a taxable estate are subject to which tax or taxes?

I. Estate tax

II. Income tax

A) I only

B) II only

C) Both I and II

D) Neither I nor II

Answer 3

C) Both I and II

An IRA in a taxable estate will be subject to both estate tax and income tax. The IRA balance is treated as taxable income for income tax purposes.

Question 4

The client has four assets, each worth $100,000. First is a CD. Second is highly appreciated, raw land. Third is an appreciated portfolio of stocks. The other is a nonqualified deferred annuity. Which would be the most tax-efficient to pass to a public charity at death?

A) CD

B) Land

C) Stock

D) Non-qualified deferred annuity

Answer 4

D) Non-qualified deferred annuity

Funds inside a non-qualified deferred annuity grow tax-deferred. IRS penalties apply for withdrawing funds early. In addition, money withdrawn comes out as “worst first,” with gain is treated as ordinary income.

Question 5

“All life insurance is built from the same elements.” What elements figure in all insurance products?

I. Premium, cost of mortality, administrative and commission expense loads

II. Guaranteed cash value and projected cash value

A) I only

B) II only

C) Both I and II

D) Neither I nor II

Answer 5

A) I only

Not all policies have cash value. Term insurance does not.

Question 6

What is guaranteed-issue life insurance?

A) Offered without having to pass a physical or otherwise show proof of insurability

B) Issued to cover specified causes of death, such as accidental death

C) Premium is guaranteed not to increase

D) Issued subject to a guaranteed right to get all premiums back after a specified period of years

Answer 6

A) Offered without having to pass a physical or otherwise show proof of insurability

Question 7

When a policy is sold with the donor giving the charity the money to pay the premiums on a policy that the charity owns on the donor’s life, experience shows that it is best to limit the premiums required to 1 to 5. Why is this?

I. It is simple for the donor to understand.

II. It limits the risk to the charity of the donor’s failure to pay future premiums.

A) I only

B) II only

C) Both I and II

D) Neither I nor II

Answer 7

C) Both I and II

Question 8

Who may solicit an insurance application?

I. Licensed insurance agent

II. Fundraiser

A) I only

B) II only

C) Both I and II

D) Neither I nor II

Answer 8

A) I only

Soliciting and selling life insurance requires proper licensing. The fundraiser could qualify the donor for charitable intent, then have the donor work with a licensed agent.

Question 9

With respect to life insurance, under which scenario(s) below will the donor be able to take an income tax deduction?

I. The donor writes a check to the charity; the charity pays the premium on a policy the charity owns on the donor’s life.

II. The donor pays the life insurance premium to the insurance company; the donor owns the policy; the charity is the irrevocable beneficiary.

A) I only

B) II only

C) Both I and II

D) Neither I nor II

Answer 9

A) I only

The charity must own the policy and have all rights of ownership. The donor is best advised to write the check to the charity, then have the charity pay the premium. This makes it easy for the donor to substantiate the deduction, since the donor will get a receipt for the cash. The donor could pay the premium directly to the charity, and it would be deductible, but it may be more difficult to substantiate the deduction. Also, the gift paid directly to the charity qualifies for the 50% AGI limitation. A gift made by having the donor pay the premium with the charity as the owner may be considered a gift “for the use of” the charity and will, as such, limit the deduction to 30% of AGI.

Question 10

The donor has a policy on which she paid $5,000 a year for 10 years. Its cash value is $65,000. There is no unearned premium, and no loan against the policy. What is the deduction?

A) $5,000

B) $50,000

C) $65,000

D) $15,000

Answer 10

B) $50,000

An in-force policy in premium-paying mode is generally deductible at the lower of interpolated terminal reserve or basis. Interpolated terminal reserve is cash value plus unearned premium minus loans. In this case, there is no unearned premium or loan, so the gift value is the lower of basis (premiums paid) or cash value. It is also worth noting, however, that a qualified appraisal is required when the gifted policy is worth more than $5,000. The point of the question, as framed, however, is to remind the student that cash value, or interpolated terminal reserve, may significantly exceed the gift value for policies with gain in them.

Question 11

The donor has a paid-up policy. He paid $10,000 a year for 10 years and has an adjusted cost basis of $100,000. The replacement cost of such a policy is $115,000. The face amount is $500,000. What is his deduction?

A) $100,000

B) $115,000

C) $500,000

D) $385,000

Answer 11

A) $100,000

The deduction is for basis or replacement cost, whichever is less. (A qualified appraisal, however, will be needed for a policy worth more than $5,000.)

Question 12

The donor has a life insurance policy with a loan against it. The donor gifts the policy to charity. Which statement or statements below is (are) true?

I. The donor will be treated as having made a bargain sale.

II. Under the private benefit rules (in the charitable reverse split-dollar regulations), the loan may disqualify the deduction altogether.

A) I only

B) II only

C) Both I and II

D) Neither I nor II

Answer 12

C) Both I and II

Question 13

A policy whose fair market value is more than $5,000 must, to substantiate the deduction, have a qualified appraisal. The Pension Protection Act of 2006 specifically excludes all the following from being a qualified appraiser, EXCEPT:

A) The donor

B) The donee

C) A related party or party to the transaction, such as the insurance agent/broker or the insurance company

D) An independent expert with suitable credentials and experience, who does this appraisal work regularly

Answer 13

D) An independent expert with suitable credentials and experience, who does this appraisal work regularly

The point is that the charity, donor, agent, and insurance company are excluded.

Question 14

With respect to “insurable interest” in the life of a donor, which statement or statements below is (are) correct?

I. Whether charities can apply for and own life insurance on the life of a donor is a matter of state law.

II. Insurance companies differ dramatically as to how much insurance they will write on a donor when the policy is owned by and paid to a charity.

A) I only

B) II only

C) Both I and II

D) Neither I nor II

Answer 14

C) Both I and II

Question 15

With respect to a charity’s purchasing insurance on the life of a donor, which statement or statements is (are) true?

I. The insurance a charity buys on the donor’s life may reduce the amount the donor may be able to purchase later for personal purposes.

II. Insurance companies differ significantly as to how much life insurance they will allow a charity to buy on a donor.

A) I only

B) II only

C) Both I and II

D) Neither I nor II

Answer 15

C) Both I and II

Question 16

“The life insurance illustration is not the policy.” Each of the statements below properly draws out the implications of this statement, EXCEPT:

A) Insurance illustrations are based on many factors, some of which may not be guaranteed.

B) Policy performance over time, particularly for policies with cash value, may differ dramatically from that projected in the sales illustrations.

C) To replace an old policy which has had disappointing performance with a new policy that illustrates better may or may not result in a new policy that performs better over time.

D) The life insurance illustration is not a valid contract, unless it is dated and signed by the life insurance agent, the owner, the applicant, the insured, and a suitable representative of the issuing carrier’s underwriting department.

Answer 16

D) The life insurance illustration is not a valid contract, unless it is dated and signed by the life insurance agent, the owner, the applicant, the insured, and a suitable representative of the issuing carrier’s underwriting department.

The illustration is not contractual. It is sales material.

Question 17

When an in-force life insurance contract is sold to a company that purchases it as an investment, which term or terms are used for this transaction?

I. life settlement

II. viatical

A) I only

B) II only

C) Both I and II

D) Neither I nor II

Answer 17

C) Both I and II

Question 18

Charities have “gift counting” policies and procedures. Which statement or statements below is (are) true of “counting” life insurance policies?

I. The gift counting policy determines how the policy will be counted towards campaign totals.

II. The gift counting policy determines how the donor will be credited for donor recognition levels.

A) I only

B) II only

C) Both I and II

D) Neither I nor II

Answer 18

C) Both I and II

Question 19

According to the course author, what are the “three P’s” that a charity should bear in mind when contemplating a gift of a life insurance program?

A) Product, price, and performance

B) Product, promotion, and premiums

C) Product, process, and provider

D) Promotion, premium, and performance

Answer 19

C) Product, process, and provider

The course means to draw attention to the importance of process and provider beyond just the product specifications. Performance going forward, particularly when account is taken of inflation and long-term company solvency, is an unknown. The charity can consider the product, but will most often have to rely on the judgment of a provider–an agent, that is–and the company he or she represents. Thus, the choice of provider is critical. Also, each provider will have a preferred process. In choosing the provider, it is important to know how donors will be treated.

Question 20

With regard to life insurance and philanthropy, the course emphasizes that there are, in general, two main ways that life insurance can be placed for a charitable purpose. What are those two?

A) A packaged gift opportunity versus a product sold within an overall legacy plan, in which the donor/client’s overall objectives are met by an ensemble of many tools and strategies

B) Charity-owned versus individually owned life insurance

C) Permanent versus term insurance

D) Deductible versus nondeductible premiums

Answer 20

A) A packaged gift opportunity versus a product sold within an overall legacy plan, in which the donor/client’s overall objectives are met by an ensemble of many tools and strategies

Insurance can be seen as a tool unto itself, owned by the charity or owned by the donor, but considered all by itself. This is called “package selling” in the insurance industry. The alternative is to assess client and donor needs and to meet those needs, including the desire to help charities, with an appropriate ensemble of products, services, tools, and techniques. What is the agent’s process? That is a point on which charity and agent should agree.

Question 21

10 years ago, a charity conducted a life insurance campaign. They received a total of 30 whole life polices and 7 universal life policies. The total face amount is $3 million. Each was funded to pay for itself after the donor had gifted the first 4 premiums, based on the then current non-guaranteed illustrations. Subsequently, the person in charge of the insurance campaign left the charity. No one has looked at these policies since then. What is the most likely outcome?

A) The charity will eventually receive $3 million from these “paid-up” policies.

B) The charity will eventually receive more than $3 million, since some of these policies are likely to increase in value through dividends and other credits.

C) The charity may receive much less than the expected amount, given the drop in interest rates over the last ten years. These policies are almost certainly underfunded, and many may lapse altogether.

D) The charity should be able to receive $3 million at death of the donors while also tapping these policies from time to time for their cash value.

Answer 21

C) The charity may receive much less than the expected amount, given the drop in interest rates over the last ten years. These policies are almost certainly underfunded, and many may lapse altogether.

The point is that policies are dynamic entities; their actual values and their need for continued funding will depend on a complex interplay of policy guarantees and current economics. Policies need to be managed. To neglect them, as in this example, is not good stewardship and may lead to unhappy outcomes.

Question 22

The donor has four major assets. The first is a personally owned life insurance policy with a face amount of $100,000. The second is an IRA worth $100,000. The third, also worth $100,000, is a single-premium deferred annuity with a basis of $25,000. The donor wants his/her daughter to receive $100,000 at the donor’s death, and for a charity to receive $100,000. Which asset would you recommend go to the charity, and how?

A) Life insurance via beneficiary designation

B) IRA via beneficiary designation

C) Non-qualified deferred annuity

D) Life insurance policy paid to estate, then cash given to charity

Answer 22

B) IRA via beneficiary designation

The best answer is the IRA. The IRA is full of taxable income. In the hands of the daughter, that income will eventually be taxed, whether she cashes it in or takes income from it. In the hands of the charity, however, no income tax will be paid. With a deferred annuity, the same logic applies, but the annuity has some basis in it, so some of it would not be taxed in the hands of the daughter. Life insurance paid to daughter makes sense because she would get it via the beneficiary designation tax-free. The point is to look to the IRA in a fact pattern, if you want to find the most tax-efficient gift.

Question 23

According to Russell James, which of these factors is by far the greatest leading indicator of a bequest?

A) No heirs

B) Higher wealth

C) Higher income

D) Single surviving spouse

Answer 23

A) No heirs

By far the largest factor is the lack of any children or grandchildren.

Question 24

With respect to the IRA charitable rollover, which statement or statements below is (are) correct?

I. The donor must be over age 69 1/2

II. The donor may give $100,000 from the IRA to charity once during his or her lifetime without Federal tax consequences

A) I only

B) II only

C) Both I and II

D) Neither I nor II

Answer 24

D) Neither I nor II

Neither is correct. The donor must be 70 1/2 or older, and may give $100,000 each year without Federal tax consequences.