Over the Jewish holiday of Sukkot in 2021, I was happy to participate in a backyard event coordinated by the Jewish Foundation of Greater Toronto, co-hosted by my colleague and fellow Professional Advisory Committee member Larry Berdugo and Jaymie Bongard. It was the first time many of us had gotten together live and not virtually in quite some time, and beyond the enthusiasm and exuberance of meeting in person, the attendees, consisting of primarily life insurance agents, were quite keen on hearing about life insurance-based strategies that could enhance and accelerate their clients’ philanthropic objectives. As one of the evening’s presenters, I covered a number of strategies and will provide a brief outline of some of the key themes that were presented.
Legacies people leave behind are a testimony to the lives they have led, so if one can enhance their gift to the causes they feel most passionate about, their legacy can also be enhanced. There are a number of ways that one can realize their philanthropic objectives. These can be usually divided into two categories: (i) current; and (ii) deferred gifts. Current gifts can include gifts of cash, in kind donations (tangible personal property, cars, real estate, furnishings, collections, etc.), publicly traded securities, privately held shares and immediate annuities. Deferred gifts can include charitable bequests, life insurance proceeds, charitable remainder trusts, residual interest and deferred annuities. Within the deferred gifts category, gifts of life insurance are quite common, and many donors are familiar with the concept of giving through life insurance as a planned gift.
There are a number of methods of gifting life insurance, including transferring ownership of a paid-up policy, transferring ownership of an existing policy on which premiums are payable, and purchasing a new policy with the charity as owner and irrevocable beneficiary. The advantage to the donor of transferring ownership of a paid-up policy is a tax receipt for the fair market value of the policy with an adjustment made for any cash value. An independent actuarial calculation determines the fair market value of the policy.
For example, a male age 65 who owns an existing Term to 100 policy with no cash value and with a $1,000 annual premium may have their policy assessed at $35,000 and the charity would issue a charitable donation tax receipt for $35,000. The valuation should be carried out to comply with the general guidelines outlined in paragraphs 40-41 of the CRA Information Circular 89-3 “Policy Statement on Business Equity Valuations”, which the CRA has indicated should also be used for this type of valuation.
For donation of policies with cash values, a disposition also arises when a policy is gifted to a charity. Special rules in subsection 148(7) of the Income Tax Act determine the proceeds on such a gift or transfer, as well as the adjusted cost base (ACB) of the policy to the recipient. These rules were revised in 2016: where the transfer takes place, the transferor is deemed to receive proceeds equal to the higher of the policy’s cash surrender value (CSV), the fair market value (FMV) of the consideration given for the policy or the policy’s ACB at transfer.
Therefore, for the $100,000 policy transferred to a charity, with a CSV of $30,000 and with an ACB of $20,000, the donor’s proceeds will be the greater of the policy’s CSV and ACB. So, in this case a taxable gain of $10,000 would apply and reduce and offset the benefit provided by the $35,000 charitable donation tax receipt. Typical factors to be considered in determining the value of policies may include:
In our case study, where the charitable donation tax receipt for FMV is $35,000, a higher potential value could be assessed for reduced life expectancy, due to poor health. The benefit to the donor is instant tax relief that can be carried forward over 5 years, and the charity receives a substantial future gift. Donors who would typically benefit from such arrangements would include retirees with paid up policies who have outlived the original need (e.g. family or mortgage protection) of the policy and want to give to charity, but do not have other assets. Moreover, business owners who have sold their active business or wound down their partnerships and their policies have become redundant benefit from this gifting arrangement.
Purchasing a new policy can be structured where naming a charity as beneficiary of a policy owned by the donor allows for a large donation credit based on the death benefit, and is available to the estate of the donor to be used to offset terminal taxes of the deceased. The charity can also be named as owner and irrevocable beneficiary entitling the donor to tax receipts as premiums are paid. This structure is ideal for leveraging a large gift to a favourite charity on an installment basis and saves taxes during the donor’s lifetime.
For example, if the donor purchases a $100,000 policy paid up after 10 years with the charity as owner and irrevocable beneficiary, the annual premium of $1,520 would entitle the donor to an annual receipt for the full premium, resulting in a net after tax outlay of $815 or only $68 per month. The cumulative net outlay over 10 years would only be $8,147 and the charity would benefit from a $100,000 future gift.
However, many charities have a need for current cash flow to distribute much needed funds and sometimes prefer current donations to deferred bequests, endowment, and testamentary gifts. Accordingly, where life insurance is generally used for estate gifts, certain permanent life insurance policies with cash values, such as universal life or participating whole life plans, can provide an alternative source of funds. If structured properly, a policy can have substantial liquidity and cash values, even in the earlier years of the contract. The strategy entails having the charity as owner and irrevocable beneficiary of the policy. The donor would fund the premiums annually, contributing the maximum allowable under the maximum tax actuarial reserve (MTAR) rules, creating significant cash values as early as the first year. In the case of a participating whole life policy, at the 2nd year policy anniversary and every subsequent policy anniversary, the policy owner, being the charity, can withdraw or strip out the cash dividend each year and utilize the cash for current needs.
For example, if a 61-year-old male non-smoker deposited $100,000 annually towards the policy for 20 years as part of his annual gifting strategy, at the 2nd policy anniversary the charity who owned the policy could withdraw $85,000 and use it to distribute funds for current needs. The life insurance policy would be worth $1,000,000 and remain at that level until the death benefit proceeds are paid upon the donor’s passing. In subsequent years, the withdrawals would vary and increase annually ranging from approximately $50,000 to $75,000, depending on the policy’s annual dividend. Note, a cash value withdrawal (a surrender or partial surrender) and a policy loan are dispositions of an exempt policy. At the time of a disposition, the proceeds of the disposition that are in excess of the policy’s ACB are typically treated as a taxable policy gain. This amount, if any, is usually reported on a T5 slip by the insurer. It is treated as ordinary income, like interest income, not a capital gain. If realized by a corporation, this income is considered passive investment income. Since registered charities as the policy owner in this strategy enjoy tax exempt status, there is no ACB grind, and the tax consequences of a disposition would not apply.
In this strategy, the cumulative total of the combined cash withdrawals and the estate gift would exceed and could potentially be many times higher than straight year over year cash donations without an insurance policy, depending on the age and life expectancy of the donor. The donor would also be entitled to the tax receipts on the full premium as well. The strategy has the benefit of creating both current and deferred funds for charities. In the April 2022 federal budget, the government proposed increasing the Disbursement Quota (DQ) rate to 5% from 3.5% for the portion of property registered charities do not use in charitable activities or administration that exceeds $1 million. Some stakeholders in the charitable sector believe that a higher DQ ensures that donations are not held for too long. On the other hand, drawing on capital to meet the requirement risks the ability of charities to meet their goals in future years. An enhanced charitable giving structure such as the one described above, enables BOTH the use for expenditures towards current charitable purposes through cash value withdrawals and maintains the charity’s ability to meet future goals through the estate portion of the insurance proceeds. Charities should consider reviewing their portfolios and endowment funds to determine if this structure would be suitable. And whereas insurance polices are currently exempt from the DQ rules, cash withdrawals would help charities meet and even exceed the minimum disbursement quotas set forth by the CRA. For the recipient charity, the ultimate insurance payout of the death benefit proceeds would provide ongoing funds to re-seed the recipient charity with additional funds as a deferred gift.
About the Author
Eric Benchetrit is a financial services industry consultant, providing financial advisors, life insurance agents, clients and related industry professionals, expertise in complex tax and estate planning, technical assistance, case packaging and competition analysis for the myriad of insurance and financial products and services available in the marketplace. Eric is considered by his peers as one of the most informed and knowledgeable authorities in his space and advisors often utilize his expertise to conduct joint field calls and meet with client’s professional advisors including CPAs, tax and estate lawyers and to speak on their behalf at client seminars. His opinions and expertise are also regularly called on by life insurance companies to assist in their product development and he sits on some of their advisory boards.
As a sought-after educator, he’s also been a faculty member and part-time Professor for Seneca College’s Financial Services Practitioner certification program. Graduates of this program complete a portion of the coursework for eligibility for the CFP (Certified Financial Planner) Professional Competency Examination as well as credits towards their CLU (Chartered Life Underwriter) designation.