GIFTS OF LIFE INSURANCE

Transcription

1 GIFTS OF LIFE INSURANCE A gift of life insurance is an attractive way of making a charitable donation because it enables a donor to make a significant future gift at a modest cost. A number of gifting options are available: Option 1: Option 2: Option 3: Option 4: The donor can purchase a new policy then immediately gift it to the charity. The charity would be owner and beneficiary of the policy. The donor can contribute an existing policy to the charity. The charity would be owner and beneficiary of the policy in this case as well. The donor can retain ownership of the policy and designate his or her estate as beneficiary. All or a portion of the proceeds would be paid to the charity under the donor s will. The donor can retain ownership of the policy and designate the charity as beneficiary. The advantages and disadvantages of these various options are discussed below. Prior to 1996, donations could be claimed to a maximum of 20% of net income. This made it more attractive for donors to select Options 1 or 2 above. In those cases, a tax credit would be available for premiums paid by the donor under the policy owned by the charity. Under Option 2, a tax credit would also be available for an amount equal to the cash surrender value of the gifted policy. No tax credit was available for insurance proceeds paid under Options 1 and 2, but this was usually of minimal concern given the low contribution limit. With the increase in the donation claim limit to 100% in the year of death and the preceding year it became more attractive to consider other strategies. Under Option 3, for example, there is no tax credit for premiums paid by the donor, but proceeds received by the estate and paid to charity under the will are eligible for tax credits in the year of death and the preceding year. This has the potential of eliminating income tax payable in these years. Option 3 is problematic, however, in a number of ways: Insurance proceeds are subject to creditors of the estate; The proceeds are subject to provincial probate taxes; and The gift to the charity can be delayed by problems arising in the administration of the estate, such as legal challenges to the validity of the will. These issues can be resolved under Option 4, the direct naming of a charity as beneficiary under a life insurance policy. This strategy was not possible until it was introduced in the February 2000 budget, effective for deaths occurring after It has the same income tax advantages as Option 3, but without the problems noted above. In -1-

2 most cases, therefore, Option 4 will be recommended for those wishing to take advantage of the significant income tax advantages available for charitable donations made at the time of death. Examples The examples that follow assume that the donor is able to claim tax credits within the limits provided in the Income Tax Act. The donation limits are 75% of net income with the exception of the year of the death and the immediately preceding year, in which case the limit is increased to 100%. For simplicity, the examples also assume a marginal tax rate of 45%, although rates will vary. Option 1: Purchase of New Policy Followed by Assignment to Charity Perhaps the best known method of planned giving with life insurance involves the acquisition of a new insurance policy on the life of the donor. Typically, the donor will apply for the policy than immediately assign it to the charity. The initial premium is paid by the donor after the charity becomes the owner. This avoids the complication of requiring the charity s signing officers to apply for the policy on its behalf. The charity will of course be named as a beneficiary under the policy. Consider the example of Mary, aged 46, who has discretionary income but cannot afford to make a capital contribution to the of Nova Scotia. She purchases a life insurance policy with a face value of $50,000, names the charity as owner and beneficiary and pays annual premiums of $1,600 for approximately five years. Each year she receives a donation receipt for the premiums paid. Her tax credit is approximately $720 (45%). Her out of pocket cost to make a future gift of $50,000 is only $880 per year. Option 2: Assignment of Existing Policy to Charity It is also possible for an individual to gift an existing life insurance policy to a charity. The amount of the policy s cash surrender value (if any) will qualify as a charitable donation, but the gift will constitute a disposition for income tax purposes. This will result in taxable income to the donor to the extent that the cash surrender value exceeds the policy s adjusted cost base. Any taxable income generated will partially or fully offset the immediate tax savings from the gift. However, tax credits would continue to be available on the payment of future premiums. Consider the example of Freddie who owns a universal life policy with a cash surrender value of $50,000 and adjusted cost base of $40,000. On the transfer of the policy to the of Nova Scotia, Freddie would realize income of $10,000 and, assuming a marginal tax rate of 45%, tax of $4,500 would result. However, he would also receive credit for a charitable donation of $50,000, giving him tax savings of approximately $22,500. Net tax savings to Freddie from gifting the insurance policy would amount to $18,000. Freddie would also get a tax receipt for future premiums paid on behalf of the under the policy. -2-

3 Options 3 and 4: Gift of Insurance Proceeds at the Time of Death The higher donation limits for gifts in the year of death and the preceding year make it attractive for an individual to fund charitable bequests with life insurance. A policy owned by the donor, with his or her estate named as beneficiary, can be used to pay charitable bequests provided for in the will. Consider the simple example of an individual, Janet, who owns marketable securities in respect of which capital gains of $270,000 (taxable portion $135,000) would be realized on death. She also has RRSPs of $350,000 that would be fully taxable on her death. The securities and RRSPs would create $485,000 of taxable income in the year of Janet s death, resulting in a tax liability of $218,250 if a marginal tax rate of 45% is applied. The tax liability would reduce the value of her estate available to her beneficiaries. She wants to preserve as much of her estate as possible for her children, while making a sizable charitable gift to the of Nova Scotia on death. A traditional strategy for Janet would be to acquire $218,250 of life insurance to pay her tax liability. She could, however, go one step further and acquire $485,000 of insurance, the proceeds of which would be paid to her estate and be used to make a gift to the under the terms of her will (Option 3). In this example, the $485,000 gift would have the effect of eliminating her income tax liability in the year of death. If the amount of the gift exceeded the amount necessary to eliminate all taxes in the year of death, the excess could be carried back against Janet s income in the year prior to her death. Under this strategy, Janet retains ownership of the life insurance policy, and therefore has complete control over its use. It also provides her with the ability to significantly reduce or eliminate income tax in the year of death, and the preceding year, while making a generous charitable gift. There is no tax relief to Janet while she is alive. One drawback of this strategy is that it exposes the proceeds to probate fees, creditors of the estate and to delays in the administration of the estate (such as legal challenges). For this reason, Janet would likely prefer to name the of Nova Scotia, rather than her estate, as beneficiary of the policy (Option 4). She would obtain the same income tax advantages as if the gift had been made through her will, but would avoid these other potential problems. GIFT OPTIONS AND TAX IMPLICATIONS SUMMARY Owner Beneficiary Donation Receipt During Lifetime CSV 1 at date policy transferred plus annual premiums Donation Receipt Upon Death None Donor Estate None Amount of gift made in will Donor None Amount of insurance proceeds 1 Cash Surrender Value -3-

4 PROCEDURE FOR MAKING A GIFT OF LIFE INSURANCE Assigning Ownership of a Life Insurance Policy (Options 1 and 2 above) 1. Transfer ownership of the new or existing policy to the of Nova Scotia and continue to pay premiums. 2. Upon death, the policy proceeds are paid directly to the of Nova Scotia by the life insurance company. 3. Charitable donation receipts are generally based on cash surrender value ( CSV ), if any, of policy at the date of ownership transfer plus any additional premiums paid by the donor. The excess of the cash value over the adjusted costs basis of the policy is taxable to the donor. Naming an Estate as Beneficiary with Bequest of Proceeds (Option 3 above) 1. The estate is named as the beneficiary of the policy and then a bequest to of Nova Scotia is included in the Will. 2. Upon death, the insurance proceeds are received by the estate and paid by the executors to the of Nova Scotia (proceeds are subject to probate fees and estate creditors). 3. The donor is issued a receipt for the amount of the gift. 4. The donation may be claimed on the donor s taxes in the year of death or the preceding year. The maximum claim for donations in the year of death and the preceding years is 100% of the donor s income in each of those years. (Life insurance proceeds are not taxable, so the full amount of the donation tax credit is available to offset taxes on other income such as capital gains or RRSP income triggered upon death). Naming the of Nova Scotia as Beneficiary of the Life Insurance Policy (Option 4) 1. The of Nova Scotia is named as the beneficiary of the policy. 2. Upon death, the life insurance company pays the policy proceeds directly to the of Nova Scotia. 3. The donor is issued a receipt for the amount of the insurance proceeds, subject to the same 100% donation limit described above. 4. This approach may be preferred by donors who wish to keep the insurance policy proceeds out of their estate or need to have access to the cash value of the policy or the flexibility of changing named beneficiaries. -4-

5 Please provide details of your gift to the of Nova Scotia in order that we may satisfy your philanthropic wishes and ensure that a tax receipt is issued at the appropriate time. To establish a Fund, please contact us today at (902) The of Nova Scotia staff will work with the donor (and his or her advisors) to develop terms which will enable achievement of all philanthropic objectives. DISCLAIMER This information/material is intended to provide general examples/ reference tools for understanding the ways in which charitable gifts may be made to the of Nova Scotia. Every effort has been made to ensure the accuracy and timeliness of the information presented. Donors reviewing this information/material should consult with professional advisors for independent advice on the optimal way to achieve their objectives. Further, any examples presented are for illustration purposes only, and should not be relied upon without the advice of professionals. 3/20/