Use charitable life insurance to trigger a tax receipt

Canada’s over 90,000 registered charities are always looking for ways to attract donors, in order to compensate for the significant reductions in government funding for various social services, education and health.

There is increased competition for these donations; the aging population and the volatility of the economy also affect contribution trends. As we witness the expected one-trillion-dollar asset transfer from one generation to the next, charitable organizations and foundations are looking for ways to get their share.

The 1966 Federal Budget increased the limit for donations made in the year of death. Subsequent Federal Budgets have introduced changes in rules and administrative policy that have added additional incentives to give and to use life insurance as a charitable tool. Among these changes is the increase of the 20% limit to 100% of income for donations made in the year of death and the preceding year. Gifts made by Will are deemed to have been made in the year of death.

Life insurance is an appropriate tool to generate funds for charities and to enjoy significant tax benefits both in life and death. Integrating a charitable life insurance policy into estate and financial plans is a win for both donor and charity.

There are three methods by which a donor can gift a new life insurance policy to a charity. They are differentiated by whether the donor wishes to receive the tax benefits on death or during his or her lifetime. There are also tax advantages to transferring an existing policy from either a person or a corporation to a charity.

1. A donor can purchase a policy and make his estate the beneficiary. His Will indicates that a gift of the amount equal to the insurance proceeds will be paid to the appointed charity on death. In this scenario, a tax credit for the amount of the proceeds is available in the year of death, with a one-year carryback. The donation limit for gifts in the year of death and in the preceding year is 100% of net income. There is no donation credit for premiums paid during a donor’s lifetime.

2. The donor transfers the policy during her lifetime to the charity. Once the policy is owned by the charity, premiums payments made to the charity or directly to the insurance company are eligible for a donation tax credit (or deduction for corporations). At death, the charity appointed as beneficiary receives the proceeds directly and the donor does not receive any tax relief.

3. The donor owns the policy and the charity is appointed beneficiary. There is no tax-donation credit or deduction during the donor’s lifetime, but the death benefit will qualify as a donation at death. The advantage of this approach over option 1 is that the donation will not flow through the Will. That means avoiding estate administration taxes (probate), creditor claims and possible estate litigation.

A word of caution: although the use of life insurance as a charitable gift is a good idea, seek out an expert familiar with the rules and nuances of the structures in order to ensure the contracts are set up properly.