Insurance Policies

Charitable donations through the giving of a life insurance policy, naming the charity as both owner and beneficiary of the policy, have helped many charitable organizations achieve substantial long-term growth.  It is generally viewed to be the least expensive way to leave a meaningful gift to a favourite charity.  Many large organizations, churches, universities and hospitals have taken advantage of this method of long-term funding.

Some advantages

1. Life insurance provides the desired capital payment for a comparatively small annual outlay during the lifetime of the donor.  The cost of a premium paid each year can provide a significant gift.
2. There is no delay in payment.  The life insurance proceeds are paid in cash. A bequest created by a will, in contrast, may not be settled for a considerable period of time.
3. There is no shrinkage due to taxes, fees, probated or administration.  The life insurance bequest is paid directly to the charity and does not form part of the estate.
4. The inadequacy of the estate does not affect the life insurance gift.  Bequests made by a will may fail (if challenged) or be reduced because of insufficient assets in the estate.  A gift of a life insurance policy would generally not be affected by claims against the estate.
5. There is no additional administration because payment by the life insurance approach is direct and in cash.  In contrast, some bequests may place burdensome obligations upon the donee.  For example, a donor may leave some income-producing property to a charitable organization.  This may involve troublesome management aspects – the collection of rent, the maintenance of the property, etc.

 How it works

There are two basic procedures which can be followed.

1. Giving an existing policy.
   If a donor already owns a policy on his or her life, he/she may wise to donate it by way of an absolute assignment (transfer of ownership) to the charity.  After the assignment, a change of the beneficiary designation to the registered charity’s name is required.
   
   The charity can issue a tax receipt for the value of the policy.   The long-standing view of the Canada Revenue Agency (“CRA”) as set out in Interpretation Bulletin IT-244R3, “Gifts by Individuals of Life Insurance Policies as Charitable Donations”, dated September 6, 1991 was that this value was the cash surrender value (CSV) less any policy loans outstanding.  The CRA has changed its position (as per its reply to question 1 at the APFF conference on October 5, 2007) and the CRA’s current view is the value of the donation receipt is the fair market value (FMV) of the policy less any advantage the donor receives.  Information Circular 89-3 provides guidance in determining FMV and includes factors such as the health and life expectancy of the life insured, cash value, replacement value, other benefits in the policy and age of the life insured.  Therefore, where FMV exceeds CSV, it may be possible to obtain a larger donation receipt when gifting a policy under this new position.  FMV is not determined by the life insurance company.  Taxpayers would need to consult with an independent actuary to have them determine this value.
   
   Where a policy with a cash surrender value is donated, a disposition will take place and depending on the adjusted cost basis of the policy, there may be an amount added to the policyholder’s income in the year of disposition.
   
   To summarize, the donation receipt can now be based on FMV while any policy gain to the donor will still be based on CSV.
   
   Any premiums paid by the donor after the ownership has been transferred will qualify as donations.
   
   An existing life insurance policy should not be given to a charity until a thorough estate planning analysis has been completed that indicates  the life insurance is no longer required for the financial protection of the heirs or other reasons.  In addition, the donor should fully understand the income tax consequences of giving an existing life insurance policy.
   
   
2. Giving a new policy
   
   If a donor applies for a life insurance policy and makes the necessary assignments to transfer the policy to the charity together with all ownership and beneficial rights, the charity will issue a receipt each year showing a charitable contribution equal to the premium paid by the donor.  Upon the death of the life insured, the insurance proceeds are received by the charity.  No tax credit is available to the donor or his estate for the death benefit paid.
   
   Note that where a new policy is purchased by a donor for the purpose of gifting the policy, no charitable receipt would be available for premiums paid prior to the transfer of the policy.
   
   Alternatively, the policy can be issued naming the charity as owner and beneficiary.  This would eliminate the necessity of transfer.  Since the charity does not have an insurable interest in the life insured the charity must obtain that person’s written consent when applying for the policy.  This approach may not be desirable for privacy and confidentiality reasons, as any underwriting questions would have to be directed to the charity as the applicant. 

Tax credit for premiums paid

Interpretation Bulletin IT-244R3 sets out that when premiums are paid on an insurance policy given to a charity, the amount of the premiums is eligible for a tax receipt as a charitable donation which can be used as a tax credit on the donor’s tax return.

The bulletin states that the tax credit may be granted on any one of three circumstances:

1. When the cash is given outright to the charity and it is used for premiums purposes;
2. When the cash is given to the charity, but subject to the provision that the funds be used to pay the insurance premiums; or
3. When payment is made directly to the insurance company with the consent of the charity.

Note that the charity would normally issue a receipt for the donation received under the first two options indicated above. However, under the third option, it should not issue a receipt until the insurance company informs it that the premium has been paid. The charity should contact the insurance company in January of each year to request a letter confirming the premiums paid during the last calendar year.

It should be noted that no donation receipt should be issued in situations where the premiums are paid by policy dividends. The charity, not the donor, owns the policy and therefore also owns the dividends. Similarly no donation receipt will be issued when the monthly charges for a universal life policy are paid from internal accounts of the policy.

Disbursement requirement

From the charity’s point of view, one limitation in accepting gifts of life insurance is the rather high quota for distribution of funds for charitable purposes that are imposed by the Income Tax Act (Canada) on registered charities.

The concept of a disbursement quota is designed to ensure that a minimum amount of the charity’s resources is applied annually to its charitable activities. Registered charities are required to disburse 80 per cent of the funds for which they issue tax receipts in the preceding year.

Premiums paid for life insurance policies that were donated to charities, and for which charitable tax receipts are issued, are added to the charity’s eligible income amount on which the 80-per-cent disbursement quota is calculated. Since the receipted premiums are not immediately disbursed to charitable sources, these premiums may create a potential problem with the disbursement quota, especially for charities which issue a large volume of receipts for premiums paid.

This problem can be overcome, at least in some circumstances, by the directed gift procedure. The CRA’s position is that if a charity is directed by the donor to hold a gift for at least 10 years, for purposes of the 80-per-cent rule, such a gift will not be included in computing the income of the charity, even thought the charity issued a charitable receipt for that gift.

In the case of life insurance, on approach is for the donor to direct that the policy be held by the charity for 10 years after the last premium is paid by the donor and is to be excluded from the calculation of the charity’s income. Such a direction must be in writing by the donor and made applicable to the gift at the time the gift is made.

As noted in paragraph 8 of IT-244R3, in order to not be included in the disbursement quota, the direction must stipulate that the gift not be spent for at least 10 years after the last premium payment of the donor.

In general terms, the direction must clearly identify the charity receiving the gift (i.e. the policy or premiums), the name and address of the donor, and the serial number of the official receipt issued to the donor for the gift. The direction should be attached to the charity’s duplicate copy of the receipt.

Planning Opportunities

1. If a prospective donor has an adequate personal and/or corporate insurance program, he or she may be readily convinced that the best way to do something special for his or her charity is through life insurance.
2. Assume that a person who has been adequately insured reaches a stage in life where some of the obligations he or she faced when younger are no longer of concern, e.g., the mortgage on the family home has been paid off. After weighing all factors in this particular situation, the policy owner may want to provide that this insurance, or part of it, be payable to a charity on an irrevocable basis. Simply naming the charity as irrevocable beneficiary will not result in and tax receipt for the policy or future premiums paid. In order for a donation tax receipt to be available and the payment of future premiums to qualify for a tax receipt from the charity, the ownership must be transferred to the charity for no consideration and it must be named as the beneficiary of the insurance policy.