Charitable giving is an important part of many people’s lives. Charities depend on benevolent individuals and corporations for funding so that they can improve our communities and help those in need. As a donor, you are contributing to an organization you feel strongly about and ensuring that it can continue to enrich people’s lives. In Canada, you are also rewarded for your gesture with the charitable donations tax credit. The tax credit provides tax relief for donors and incentive for them to give.
Charitable donations can also be accomplished through life insurance. Since you need a guarantee that the life insurance proceeds will be paid at death, you’ll need to use permanent life insurance instead of term. With term life insurance, most policies expire at age 80 or 85, so there’s a chance that the policy will expire before death. On the other hand, as long as premiums are paid, a permanent life insurance policy will always pay out a death benefit since it never expires.
There are three different methods used and each of them have their benefits and drawbacks. The tax credit provided depend on the method of donation.
Three methods of charitable giving using life insurance
Bequest through a will: Life insurance proceeds can be paid to your estate, much like any other asset you own. From there, your will dictates where the proceeds go. You can indicate in your will that a bequest be made to a charity of your choice using the proceeds from the life insurance policy. A charitable donations tax credit in the amount of the proceeds can be claimed on your final tax return, up to 100% of your net income. Any remaining unclaimed amount can be carried back one year and claimed for up to 100% of net income as well.
Since the life insurance proceeds go through your estate, they are subject to probate fees and claims from creditors. Depending on the size of the estate and creditor claims, any remaining amount for the charity may be less than anticipated. The benefit of naming a bequest through the will is that a will can be updated when needs change, so it provides the donor with more control over the distribution of the death benefit.
Charity as beneficiary: Similar to leaving a bequest through a will is naming the charity as the beneficiary of your life insurance policy directly on an application. You receive the same charitable donations tax credit at death and it also provides the flexibility of the ability to change the beneficiary as you see fit. Since the proceeds are paid directly to the charity without passing through your estate, they will not be subject to probate fees or creditor claims. The entire death benefit will pass on to the charity unreduced.
Charity-owned policy: This method is unlike either of the previous two both with regards to tax treatment and control. Here, the charity owns the policy based on your life, and you continue to pay the premium. The premiums will be considered an eligible donation for the charitable donations tax credit. However, since you are no longer the owner of the policy, you won’t receive a tax credit when the death benefit is eventually paid.
You can either have the charity apply for a new policy naming it as beneficiary and you as life insured, or you can transfer an existing policy to it. If there is cash value in your policy and it exceeds the adjusted cost base, like there is in many permanent life insurance policies, you will have to include the excess in your tax return in the year of transfer. This is not treated as a capital gain so the entire amount will be added to your income. However, the cash value also generates a donations tax credit, so it will help alleviate the extra tax burden.
The drawback of this method is that once you transfer ownership to the charity, a process known as absolute assignment, you no longer have control over the policy. This means if you have a change of heart, you won’t be able to change the beneficiary.
Tax concerns and choosing your best solution to give to charity
Because of the deemed disposition of all assets at death and the resulting capital gain, as well as the entire RRSP or RRIF being added to income, many people have huge tax liabilities at death. The charitable donations tax credit from the first two options above will help alleviate some of the tax burden. As mentioned above, the donation tax credit in the year of death is limited 100% of net income. Any remaining life insurance proceeds can be carried back one year and claimed for up to 100% of net income as well. This is unlike cash donations, where the tax credit is limited to 75% of net income and can only be carried forward.
For a married couple, assets such as RRSPs and RRIFs can be rolled over tax free to the surviving spouse on the death of the first spouse. Other capital property can also be rolled over to the spouse at the adjusted cost base. This results in a lower taxable income on the final tax return of the first spouse than the survivor. Therefore, a joint last-to-die permanent policy, where the death benefit is paid on the death of the second life, is more suitable for these types of situations. The major benefit from a joint last-to-die policy is the premium saving over two separate policies or a joint first-to-die policy.
Charitable giving using life insurance can also be accomplished with a corporation. The tax benefits are similar to those for an individual, except instead of tax credits, the corporation receives tax deductions.
The methods discussed in this post provides two options: immediate tax relief or tax relief at death. Which one should you choose? If your current net income is high and you’d like an extra source of tax credit, transferring your policy to the charity as described in method three will give help alleviate some of the immediate tax burden. However, if you have a large estate that would likely face significant tax consequences on the later of you and your spouse’s death, then the first two choices will benefit you more. As usual, talk to a tax and insurance professional to find out which arrangement works best for you.
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