Leaving a Lasting Legacy: The Power of Life Insurance for Charitable Giving in Canada
For Canadians looking to leave a lasting charitable legacy while preserving their estate for their heirs, life insurance can be a powerful tool. Today, we are experiencing the early beginnings of an approximate $1 Trillion Dollar wealth transfer over the next 20 years from Canadian Baby Boomers to Millennials. These assets will go to the loved ones of those who’ve passed, and inevitably the government via tax. However, with charities increasing reliance on private donations nowadays, there are several strategies you can consider employing to make significant charitable contributions with notable tax benefits associated with these donations.
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In Canada, recent research has found that:
- Only 44% of Canadians make a Will
- Only 7% of those who make a Will leave a charitable bequest
- When asked, however, 42% would consider including charitable gifting in their Will
In this blog post, we’ll be discussing the estate-focused charitable life insurance strategy, which benefits both the charity of your choosing and provides notable taxable benefits to your final estate, helping to preserve the inheritance for your loved ones. As mentioned, this approach offers several key advantages:
Benefit 1: Estate Tax Reduction: The death benefit paid to the charity generates a tax receipt that can offset estate taxes.
Benefit 2: Probate Avoidance: Since the death benefit is paid directly to the charity, it bypasses your estate, avoiding probate fees.
Benefit 3: Estate Preservation: By using life insurance to fund your charitable gift, you can preserve other estate assets for your heirs.
Here’s How It Works…
Step 1: Purchase a Permanent Life Insurance Policy: Take out a new permanent life insurance policy. This strategy can also use an existing permanent life insurance policy that may no longer serve the originally intended benefit.
Step 2: Name the Charity: Designate a registered charity as the beneficiary of the policy.
Step 3: Pay Premiums: Continue paying premiums on the policy during your lifetime.
Step 4: Estate Receives Tax Receipt: Upon your passing, your estate receives a tax receipt for the full amount of the death benefit paid to the charity.
Step 5: Offset Estate Taxes: Use the tax receipt to offset taxes owing on your estate, potentially eliminating them entirely.
In Canada, your estate can claim charitable donations in the year of death and the preceding year, up to 100% of your net income in those years. Any excess can be carried back an additional three years. This flexibility allows for significant tax savings, often completely offsetting estate taxes.
Case Study: Meet the Johnson’s
Let’s consider a case study to illustrate how this strategy can work in practice:
– Robert and Linda Johnson, both aged 65, reside in Ontario
– Their combined estate value totals $5,000,000
– They have recently drafted their Will. They’d like to set aside $1,000,000 to Food Banks Canada, with the residual estate being received as inheritances to their two children and 3 grandchildren.
– Their current estimated estate tax bill without charitable giving is approximately $2,000,000
The Strategy:
1. The Johnsons purchase a permanent joint last-to-die life insurance policy for $1,000,000.
2. They name the Food Banks as the beneficiary of the policy.
3. They pay annual premiums of $20,000.
Upon the second spouse’s death:
– The charity receives $1,000,000 tax-free. Upon the second spouse’s passing, the Johnson estate receives a $1,000,000 tax receipt from the life insurance policy’s death benefit.
Tax Calculations:
With the Johnsons being in Ontario for tax purposes, their charitable tax receipts will be calculated as follows:
– Federal tax credit: 15% on the first $200 + 29% on the remaining $999,800 = $290,012
– Ontario tax credit: 5.05% on the first $200 + 11.16% on the next $49,800 + 12.16% on the remaining $950,000 = $126,145
– Total tax credit: $416,157
Estate Tax Savings:
– Original estate tax bill: $2,000,000
– Tax credit from charitable donation: $416,157
– Revised estate tax bill: $1,583,843
Net Result:
– Charitable gift made: $1,000,000
– Estate tax savings: $416,157
– Net cost of the gift to the estate: $583,843
In this scenario, the Johnsons have created a $1 million charitable gift at a net cost of $583,843 to their estate, while also reducing their estate tax bill by $416,157. The charity receives a significant donation, and the Johnson heirs receive a larger inheritance due to the reduced tax burden.
Final Thoughts
By strategically using life insurance for charitable giving, Canadians can create substantial legacies for their favourite causes while significantly reducing estate taxes. This approach allows you to make a lasting impact without sacrificing your estate’s value or your heirs’ inheritance. It’s important to note that while this strategy can offer significant benefits, the specific outcomes will vary based on individual circumstances, policy details, and current tax laws. Always consult with a qualified financial advisor and tax professional to ensure this strategy aligns with your overall estate plan and to maximize the benefits for both your estate and your chosen charity. Remember, the key to success with this strategy is careful planning and professional guidance. With the right approach, you can leave a meaningful legacy that benefits both your loved ones and the causes you care about most.
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