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Charitable donations totaled $9.6 billion in 2017, and this number is on the rise.
But did you know that besides donating cash, you can also give the gift of a life insurance policy?
How does it work? And what are the tax benefits?
In this post, we’ll go over your options for charitable giving using life insurance. You’ll learn:
- Which method gives you a tax credit while you’re alive and which one gives it when you pass away
- What type of life insurance you should use for charitable giving
- How using life insurance can increase your contribution by 50% compared to other investments
Let’s begin.
Charitable Giving Statistics
Each year, millions of Canadians donate money to their favourite charitable organizations. In fact, donations totaled $9.6 billion in 2017, up from $8.9 billion in 2016.
Did you know that the demographic that donates the most is people aged 65 and over? Notably, they account for over 40% of all donations. Their average donation is $2,500 per year while the national average is $750.
While large charities receive most of their funding from the government, donations account for 42% of revenue for small charities.
Did you know that…
While the most common type of donation is cash, there are other options. These include:
- Securities (shares of stocks, bonds, and mutual funds)
- Real estate
- Vehicles
- Life insurance policies
Compared to other investments, using life insurance can generate the largest donation. It’s also the most difficult to understand from a tax perspective. So let’s take a look at how you can use life insurance for charitable giving.
The first method is to have a charity own a policy based on your life.
Gift A Life Insurance Policy To A Charity
How it works
First, you arrange with a charity to buy a life insurance policy based on your life. The charity is both the owner and beneficiary of the policy.
As you pay the premiums to keep the policy in force, you receive tax receipts for it. You can claim this amount up to 75% of your net income.
When you pass away, the charity gets the proceeds of the policy and there are no more tax benefits for you or your estate.
Besides buying a new policy, you can also transfer ownership of an existing policy to the charity. In this case, you will also receive a donation tax credit for the fair market value (FMV) of the policy.
If you have a corporate-owned policy, instead of a tax credit, your corporation will get a tax deduction.
Benefits
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Bypass estate
One of the main benefits of gifting a life insurance policy is that because the charity owns the policy, it doesn't form a part of your estate. Why is that important? Because the charity gets the death benefit without it being contested by heirs or creditors.
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Tax benefit during your lifetime
The main advantage of donating a life insurance policy to a charity while you're living is the donation tax credit. You get a tax receipt for the premium you pay every year after the transfer.
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High tax credit on transfer
If you're transferring an existing policy, the tax credit you get can be very high. Remember, the tax credit is equal to the FMV of the policy. If you're in poor health and have a short life expectancy, the FMV of the policy can be incredibly high.
Drawbacks
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Loss of control
Once you transfer ownership to the charity, you no longer have control over the policy. This means if you have a change of heart, you can't reverse the process. You can't change beneficiaries, access the cash value, or make any other changes.
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Lapse
Permanent life insurance is a long-term commitment. If you change your mind later, you can stop paying premiums and the policy may lapse. That's why many charities prefer accepting paid-up policies. These types of policies don't need any further premium payments to keep in force.
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Taxable gain
Lots of permanent insurance policies like whole life and universal life have cash values. When you transfer one of these types of policies, you might have a taxable policy gain that you have to report on your tax return. Unlike a capital gain where only 50% is taxable, the entire policy gain is taxable. Fortunately, the donation tax receipt you get for gifting the policy should offset this.
Besides having the charity own the policy, you can also own the policy yourself. Let’s take a look at how this method works.
Donate The Proceeds Of A Life Insurance Policy To A Charity
How it works
There are 2 ways to donate the proceeds of a life insurance policy to a charity:
- Leave a bequest through a will.
- Name the charity as the beneficiary of the insurance policy.
In the first scenario, you name your estate as the beneficiary of the life insurance policy. The terms of your will dictate the charity that gets the proceeds.
In the second scenario, the proceeds go directly to the charity of your choosing, bypassing your estate.
In either case, when you pass away, your estate will get a donation tax credit. You can claim this credit in any year of the estate and the last 2 years of your life up to 100% of your net income.
If you have a corporate-owned policy, you’ll want to name the corporation as the beneficiary and gift the proceeds. Naming the charity as the beneficiary will have unintended tax consequences.
Benefits
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Retain control
By keeping ownership of the insurance policy and naming a charity as the beneficiary, you retain full control. So even if you change your mind, all you have to do is contact the insurance company to update the beneficiary. Or update your will if you made a bequest through your will.
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Tax credit at death
In contrast to gifting the policy to the charity, you get the tax credit at death instead of while you're alive. When CRA comes knocking on the door for its cut of your estate when you die, you can use this to offset it. The most common tax payable at death arise from capital gains and RRSP/RRIF.
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Bypass estate
If you name the charity as the beneficiary of your life insurance policy, the death benefit bypasses your estate. Instead of having the proceeds tied up in your estate, the charity gets it right away.
Drawbacks
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Unable to use tax credit
If you won't have much tax to pay when you die, you might not be able to use the entire tax credit. This could happen if you rollover your assets to your spouse when you die, deferring the tax until he/she dies. You could bypass this using a joint last-to-die policy, as discussed below.
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No tax relief during lifetime
Unlike the method of gifting a policy to a charity, you don't get any tax credit during your lifetime. Instead, the entire tax benefit with this method comes when you die.
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Tied up in estate
If you name your estate as the beneficiary and gift the proceeds via your will, there may be some unintended consequences. Since the death benefit passes through your estate, it's subject to probate fees, claims from creditors, and estate litigation. As a result, this reduces the amount that the charity would get. If you name the charity as the beneficiary of the policy, you can bypass the estate and avoid this drawback.
Should You Consider Charitable Giving Using Life Insurance?
You’re a good candidate for this strategy if the following apply to you:
1. You want to leave a larger legacy to your favourite charity than you could using other forms of donations.
2. You have the disposable income or funds necessary to buy a life insurance policy and keep it in force during your lifetime.
3. You have a large tax liability at death that you want to offset with a tax credit.
4. You want to avoid leaving a bequest via your estate where it can be tied up for a long time or subject to estate litigation.
5. You have an existing life insurance policy that you no longer have a personal (or business) need for.
What Type Of Insurance Should You Use?
Term or permanent?
The 2 main types of life insurance are term and permanent. Term insurance becomes astronomically expensive later in life and expires between age 80-85. So using it for this purpose is out of the question.
However, if you have an existing term policy, you can convert it to a permanent policy before donating it to the charity. You’d want to do this if your health is poor enough that you can’t buy a new policy at reasonable prices. Also, because the premium is based on the age when you make the conversion, the younger you are, the lower the premium.
If you’re buying a new policy for charitable giving, you need to get permanent insurance. With this type of policy, you get coverage that lasts a lifetime so the charity is guaranteed to get the death benefit when you die.
You can even structure the policy so that the death benefit increases every year. This prevents the effects of inflation from diminishing the payout years down the road.
Joint last-to-die
Instead of a policy based on your life, you can buy a joint last-to-die policy on your and your spouse’s lives. This pays out a death benefit when both you and your spouse dies.
One of the benefits is that you save on premiums compared to a single life policy. Not only that, but because you can defer taxes until the latter death, the tax credit you get at death is timed perfectly to offset this.
Case Study: Increase The Value Of Your Charitable Contributions By 50%!
We mentioned that using life insurance can generate the largest donation compared to other forms of investments. Here’s a case study to illustrate our point.
In this case study, we’re using a 60-year-old non-smoking couple buying a $100,000 whole life policy for $3,336/year. They will own the policy and name their favourite charity as the beneficiary. Their life expectancy is age 85.
As a comparison, they can put the $3,336/year into an investment account. This is a balanced account holding:
- 20% bonds yielding 2%
- 30% dividends yielding 5%
- 20% deferred capital gains earning 6%
- 30% realized capital gains earning 6%
Here are how they compare:
| Year | Annual premium/deposit | Death benefit | Investment | Difference |
|---|---|---|---|---|
| 1 | $3,336 | $100,461 | $3,439 | $97,022 |
| 2 | $3,336 | $101,050 | $6,987 | $94,063 |
| 3 | $3,336 | $101,854 | $10,646 | $91,208 |
| 4 | $3,336 | $102,923 | $14,424 | $88,499 |
| 5 | $3,336 | $104,287 | $18,323 | $85,964 |
| 6 | $3,336 | $105,967 | $22,351 | $83,616 |
| 7 | $3,336 | $107,970 | $26,512 | $81,458 |
| 8 | $3,336 | $110,300 | $30,812 | $79,488 |
| 9 | $3,336 | $112,950 | $35,258 | $77,692 |
| 10 | $3,336 | $115,916 | $39,855 | $76,061 |
| 11 | $3,336 | $119,188 | $44,612 | $74,576 |
| 12 | $3,336 | $122,752 | $49,535 | $73,217 |
| 13 | $3,336 | $126,585 | $54,631 | $71,954 |
| 14 | $3,336 | $130,917 | $59,908 | $71,009 |
| 15 | $3,336 | $135,895 | $65,375 | $70,520 |
| 16 | $3,336 | $141,310 | $71,040 | $70,270 |
| 17 | $3,336 | $147,051 | $76,913 | $70,138 |
| 18 | $3,336 | $153,027 | $83,003 | $70,024 |
| 19 | $3,336 | $159,193 | $89,320 | $69,873 |
| 20 | $3,336 | $165,523 | $95,874 | $69,649 |
| 21 | $3,336 | $172,050 | $102,677 | $69,373 |
| 22 | $3,336 | $178,763 | $109,740 | $69,023 |
| 23 | $3,336 | $185,647 | $117,076 | $68,571 |
| 24 | $3,336 | $192,720 | $124,698 | $68,022 |
| 25 | $3,336 | $199,970 | $132,618 | $67,352 |
As you can see, by life expectancy, using life insurance generates a 50% larger contribution to the charity than the investment account.
The advantage doesn’t end there. Because the investment account has to pass through the estate, it’s further reduced by probate fees and potential creditor claims.
This case study shows the incredible potential of using life insurance as a charitable donation.
Conclusion
Which type of charitable giving using life insurance should you choose?
How much do you want to give?
Drop a comment in the section below and let us know how you want to leave a legacy for your favourite charity.
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