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Charitable Giving and Life Insurance Part 2: Wealth/Estate Replacement Strategy


Do you want 100% of your wealth preserved for your family, or favorite charity, or only 100% of what is left over after the government takes its share?


Last month, I wrote about how the gifting of a life insurance policy can be an attractive option for any prospective donor and an important component of their overall charitable giving strategy. I summarized the two ways one can donate to charities using life insurance:

  • Donating a policy during life and

  • Donating the proceeds upon death. I also reviewed the tax implications pertaining to both methods.


In this article, I’ll explore the two most common charitable giving strategies combining permanent life insurance with other investments.


Strategy #1: The client donates public securities/seg funds/mutual funds to a charity and uses tax savings to fund an insurance policy.


An increasingly popular option among donors giving to charities is gifts-in-kind. In this scenario, the charity doesn’t receive the typical “cash” donation but rather another tangible asset. Typically, gifts of capital property made to a charity are deemed to be disposed of at FMV for tax purposes of which 50% of the gain is taxable to the donor. Under certain circumstances, gifts in kind receive special tax considerations under CRA guidelines. In the past 20 years CRA made it easier for individuals (and corporations) to donate to charities by introducing a zero-percent capital gains inclusion rate on the following types of eligible capital property:


  • Stocks, bonds, and other publicly traded securities

  • Shares in a mutual fund corporation

  • Units in a mutual fund trust and

  • Segregated funds

  • Certified Canadian Cultural or Ecological Property (*items of “outstanding significance and national importance” and would include art and historical artifacts)


A zero-percent capital gains inclusion rate means that none of the capital gains, if any, is included in the donor’s income for tax purposes because of the gift.

Let’s look at an example (See chart below): Jessica and Bill (age 60 n/s) would like to donate $100K to their favorite charity. They own a seg fund portfolio with a FMV of $100K and ACB of $50K. They’re in a 50% marginal tax bracket and make enough income to be able to claim the full amount of the donation receipt in the year that it’s made. The first column highlights what would happen if they liquidated the investment and donated the proceeds. The second column highlights the result of them simply donating the seg fund (in-kind) to the charity. In the final analysis, by donating the seg fund portfolio rather than cash, they would save $12,500 in taxes.


We can take this a step further and introduce a “wealth replacement” strategy (third column). If the couple would also like to leave something behind for their heirs and mitigate the erosion of their estate created by the gifting of the seg fund to the charity, they may want to use the tax savings from the donation tax credit to fund a life insurance policy. The life insurance policy will replenish the estate. Here’s how it would work. Let’s assume for simplicity purposes, the charity receives a portion of the segregated fund portfolio each year for 10 yrs. ($10,000 each year for 10 years) as opposed to a one-time donation. The donation tax receipt created equals $10,000 per year which results in tax savings of $5,000 per year. We’ll use these tax savings to fund a life insurance policy. At year 25 (age 85), the charity would have received $100K in donations over 10 yrs. and Jessica and Bill’s estate is replenished with insurance proceeds of approximately $167,000 and a residual balance (nominal value) from the segregated fund portfolio.



What about Corporations?


A similar strategy of donating eligible capital property (as listed above) can be used by corporations with the added benefit that the full amount of the capital gain (ie $50K in above example) is added to the corporation’s capital dividend account which can eventually be paid out to the shareholders on a tax-free basis. A donation tax receipt equal to the value of the FMV of the capital property donated will be issued and fully deductible against corporate income. If life insurance is included as a wealth replacement strategy, this will provide an additional lift to the corporation’s capital dividend account equal to the total death benefit minus the ACB of the policy, assuming that the proceeds are donated to the charity and not the heirs. Once again, donating to the charity would also give rise to a donation tax receipt for the full amount of the life insurance proceeds that is fully deductible against corporate income.


Strategy #2: The client expects to own registered assets (RRSP/RRIF) at death.


Another common strategy is where a client anticipates owning registered assets (RRSP/RRIF) at death. In this scenario, they’ll likely have a significant tax liability that can be eliminated by gifting those assets to a charity. The FMV of investments held within registered plans (RRSP/RRIF) is included in the individual’s income in the year of death unless rollover is available to a spouse or eligible dependent.


Let’s look at an example: Jerry and Tiffany Smith are both 65 years old and have a significant registered (RRSP/RRIF) portfolio which is anticipated to be valued at $1,000,000 at life expectancy (age 85 or year 20). They also have a non-registered portfolio which is projected to be valued at $1,000,000 at the same time and is made of mostly tax-paid assets. Their 3 kids are the beneficiaries of the registered account and estate. Their marginal tax rate at death is 50%.

Here are the various scenarios (see chart below):



Without planning (first column), the Smith’s will have a total of $1.5 Mill to distribute amongst their kids and charities if wanted. If they name a charity(s) as a beneficiary (second column) of the registered portfolio (RRSP/RRIF), $1 Mill will go to the charity and $1 Mill will be divided amongst the kids. If they incorporate a “wealth replacement strategy” using permanent life insurance (third column), they can enhance their gift to their kids by roughly $400k (or more to the charity if desired).


Charitable giving with life insurance can involve strategies where a charity receives other assets (non-insurance) and the donor’s estate receives insurance proceeds. The two estate replacement strategies discussed in this article showcase ways for a donor to maximize (or stretch) their existing wealth to enhance their gifts to both charities and/or heirs by accessing various tax benefits in addition to the donation tax credit.



Tony Gallippi, B.A.S (Hons.) CFP CLU

Advanced Case Consultant

QFS



This communication reflects the views of Qualified Financial Services Inc. as of the date published. The information in this publication is for general information purposes only and is not to be construed as providing individual legal, tax, financial or other professional advice. Qualified Financial Services Inc. assumes no responsibility for any errors or omissions in the information contained herein nor for any reliance placed on such information. Please seek independent professional advice before making any decisions.

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