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University of Northern Iowa athletic department owns up to 10-year insurance blunder

August 24, 2009

Many businesses have come to regret a gimmicky life insurance plan that seemed like a great idea when the salesman explained it. Now the University of Northern Iowa has joined this unhappy crowd, reports the Des Moines Register:

Nearly 1,700 contributors to a University of Northern Iowa athletic scholarship fund lost an estimated $6.8 million in accumulated insurance this year when school officials determined the benefit violated federal tax law, according to documents obtained by the Des Moines Sunday Register.

The donors and the university may owe the federal government three years of back taxes because it took so long for them to recognize that the program should have been discontinued 10 years ago, when tax law was changed, school officials acknowledged last week.

The donors received term life insurance credits based on the amounts donated. Unfortunately, the tax law doesn't care for such arrangements:

In 1999, Congress had approved two changes in the tax laws governing charities. Under one change, a donor's contribution would not be tax-deductible if the charity paid an insurance premium on behalf of the donor and the beneficiary was the donor or a member of the donor's family. The second change imposed a 100 percent excise tax on the charitable organization for any amount of money spent on an insurance policy premium for the donors - estimated by UNI officials at $50,000 annually.

So - no deduction for the donors, and a big tax penalty for UNI. Not good for the Panthers.

I believe these harsh provisions arose because of "Charitable Split Dollar" plans marketed in the 1990s, usually in cooperation with the now-bankrupt charity National Heritage Foundation. The plans purported to make life insurance purchases deductible, with the charity basically taking a fee for taking part in the deal.

The Moral: The tax law governing life insurance is very complicated. When the the salesman tells you that he has a product that will give you insurance free because of special tax benefits, make sure to talk to your tax pro before you sign.