Giving the gift of life insurance to charity

Two years of pandemic life have taken a toll on many organizations, including charities, many of which have seen revenues decline¹ while the need for assistance and support has increased.² Add in the onset of a war and ongoing environmental concerns, and it’s clear that there’s an urgent need for giving on many fronts.

The Canadian government has a history of providing generous tax incentives to donors, and in terms of tax-efficient ways to give, the spectrum of possibilities is wide. Take, for example, a personal gift of cash as a base-case scenario. In British Columbia, an individual with income that is taxed at the highest marginal tax rate may realize a tax credit on their cash gift of 53.5%, yielding an after-tax cost of giving of 46.5%—not bad for a base-case scenario.

Other gifting possibilities include the donation of publicly traded securities or other assets, gifts made at the corporate level, gifts of mining flow-through shares, donations of registered assets (such as RRSPs, RRIFs, and TFSAs), and the gifting of life insurance. When planned carefully, making charitable contributions using one or more of these methods can further reduce the after-tax cost of giving from the base-case scenario.

This article focuses on the gifting of life insurance, for which there are two main options.

Donating life insurance proceeds

The first option is to have the life insurance proceeds at the time of death go to a charity. This can be done either through a will or by making the charity a direct beneficiary of the life insurance policy.

When a donor gifts the proceeds of a life insurance policy—where the donor is both the owner of the policy as well as the insured—the gift is deemed to be made by the estate of that individual at the time the life insurance proceeds are donated. This is the case whether the donation of proceeds is by way of a bequest through the donor’s will or the result of a direct beneficiary designation³ made within the policy itself. In turn, under the graduated rate estate rules, the executor of the estate will have the flexibility to apply the donation either within the estate itself or to one of the deceased donor’s final two tax years.

Making a gift of life insurance proceeds through a will has the regular downsides associated with assets that pass through a will: exposure to probate fees, potential delays in estate administration, creditor claims, will challenges, and a lack of privacy. Some of these downsides can result in a reduction of proceeds to the charity or a delay in their distribution.

Designating a charity as a direct beneficiary of a life insurance policy can do away with many of these downsides. Also, if the donor names the charity as a revocable beneficiary of the life insurance policy, they will retain the flexibility to replace the charity as a beneficiary.

In either case—whether donating life insurance proceeds through a will or by designating a charity as a direct beneficiary—the donor will not receive a donation tax credit for the premiums paid during their lifetime.

Gifting ownership of a life insurance policy

The second option for donors is to gift ownership of either an existing or newly acquired life insurance policy to charity.  

Life insurance is purchased with an insurance need in mind and can serve as a tax-efficient tool that, among other uses, can provide your dependants with financial protection, provide your estate with the necessary liquidity to fund its capital gains taxes, and/or ensure that assets are divided equally and fairly among beneficiaries. If the need for life insurance changes with the passage of time, an individual can contemplate repurposing their insurance for other uses, such as making a gift to charity. Alternatively, the individual may opt to purchase a new policy for the same purpose.

With outright gifts of life insurance policies to charity, a donor is entitled to two tax incentives:

1. A donation tax credit that is equal to the fair market value of the policy being gifted; and
2. A donation tax credit for any future premiums the donor continues to pay.

The fair market value (FMV) of an insurance policy is a question of fact, but the Canada Revenue Agency (CRA) provides guidance on what to consider when determining this value (including the policy’s cash surrender value, the value of any policy loans, the policy’s face value, the insured individual’s state of health and life expectancy, policy conversion privileges, riders, and the policy’s replacement value).⁴ Given the complexity in determining a policy’s FMV, this is an exercise best done by a valuation professional such as an actuary.

Consideration also needs to be given to the applicability of the deeming provisions under subsection 248(35) of the Income Tax Act (the Act). Specifically, subsection 248(35) deems the FMV of a life insurance gift to be the lesser of the FMV otherwise determined and the policy’s adjusted cost base, where the gift of life insurance was made either:

• Within the first three years of the policy’s purchase; or
• Within 10 years of purchase, if it is reasonable to assume that the life insurance was acquired with the intention of making a gift.

Gifting a life insurance policy to charity is also considered a disposition of the policy for tax purposes, guidance for which is provided in subsection 148(7) of the Act. Basically, in this context, the donor will realize a taxable policy gain to the extent that the cash surrender value of the policy exceeds the policy’s adjusted cost base.

When all is said and done, donating a life insurance policy is a tax-efficient giving strategy worthy of consideration. Here’s an example to illustrate the effectiveness of this strategy: Let’s assume that a couple, aged 55, donates a newly acquired joint-last-to-die policy (the FMV of the newly acquired policy is $nil).

Note: To successfully gift a life insurance policy to charity, the charity must be willing to take on the gift. Also, a notable downside to gifting an insurance policy versus designating the charity as a beneficiary is that the donor relinquishes control over the policy to the charity.

Using life insurance in conjunction with other giving strategies

Life insurance doesn’t have to be gifted to charity to make an impact for charitable giving purposes—nor does a charity need to be made a beneficiary of a policy. In fact, life insurance can be used in conjunction with other charitable giving strategies and still be an integral part of a donor’s charitable giving plan.

Consider the following options for donors:

• They can use the tax savings from a donation of corporately held, publicly traded securities (which are exempt from capital gains tax on accrued gains when donated) to purchase corporate-owned life insurance. In doing so, the donor is effectively swapping a less tax-efficient corporate asset for a more efficient one while making a tax-efficient gift to charity.
• They can request that the funds in their donor-advised fund account be used to purchase a life insurance policy. Coupling this, for example, with a strategy that uses flow-through shares to fund the donor-advised fund in the first place can result in a substantial end gift to charity for a relatively small upfront cost.
• They can give private company “freeze” shares to a foundation and then use corporate-owned life insurance to create the liquidity required to redeem the shares on death.⁹ This can result in a donation tax credit, the value of which is higher than the capital gain resulting from the gift. Using life insurance to fund the redemption can provide assurance to the foundation that the shares will be ultimately converted to cash. Additionally, the resulting dividend from the share redemption can be characterized as a regular dividend, leaving the company with a valuable capital dividend account that was created by the corporate-owned life insurance.

Final considerations

There are several good strategies available to those who want to contribute to charity using their life insurance. All it takes is some careful planning and consideration. And with the need for donations continuing to grow, there is no shortage of worthy causes to support.

Farzin Remtulla CPA, CA, CFP, TEP, is an associate with ZLC Financial in Vancouver, where he specializes in providing customized life insurance and investment solutions to his clients.

This article was originally published in the May/June 2022 issue of CPABC in Focus.