Life-insurance strategy allows you to give back and have cash for family, too
Using a universal life policy means you don't have to choose between charitable giving and leaving money for your loved ones
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Most people think that if they leave a bequest to a charity they love, they would be disinheriting their children. What if you could leave a bequest without disinheriting your children?
By using the following strategy, in some cases you can do just that.
Let’s look at the case of a couple named Jane and Joe, who want to leave a bequest to their alma mater school, the University of Toronto. Jane is 55 years old and Joe is 66 years old. They have 3 adult children and two grandchildren and want to minimize taxes on their estate and maximize the inheritance for their children. They have also been donating annually to the university and wish to set up a scholarship for electrical engineering students, as they are both electrical engineers who graduated from the university’s engineering program.
Jane and Joe set up their own engineering firm 30 years ago and have grown the business into a multi-million-dollar enterprise. They have saved well throughout their lives and have $100,000 in excess cash that they do not need for their own retirement income, and they wish to donate it to the university or leave it as a bequest.
If they leave a cash bequest in their will, the university will receive $100,000 and their estate will receive a charitable-donation tax credit of approximately $50,000. Therefore, in order to leave a $100,000 charitable bequest, the inheritance that they would leave for their children would be reduced by $50,000.
Income from annuity is tax-advantaged
Instead of leaving a cash bequest, Jane and Joe can use the $100,000 to purchase a joint life annuity. A life annuity provides a guaranteed stream of income that would last until the death of the last spouse, similar to a pension. Jane and Joe can purchase a joint life annuity guaranteed to age 90; that would ensure that if they both die before age 90, their beneficiaries would receive the remainder of their funds. If Jane and Joe live beyond 90, then their beneficiaries would not receive the remainder of their funds.
Unlike other types of guaranteed income such as interest from bonds or GICs – which would be 100 per cent taxable as income – the income received from a prescribed life annuity is tax-advantaged and only a small portion of it would be taxable as income. The major portion would be considered return of capital, which is non-taxable.
The prescribed annuity option is unique to non-registered payout annuities and provides the policy owners two great benefits that can result in significant after-tax savings. These two benefits include a preferred tax status and level taxation.
The Canada Revenue Agency (CRA) assigns a preferred tax status to prescribed life annuities, which allows only a portion of the interest income to be taxed. This provides significant tax savings in comparison to other non-registered investment options. Also, unlike other investments, a prescribed life annuity has a level taxation structure, which means the taxable amount is spread out evenly over the future life of the owner.
A few conditions
Most individuals are eligible for the prescribed taxation option, provided that the source of funds is non-registered, the owner and the annuitant are the same, payments are not deferred beyond the end of the following calendar year, the guarantee period does not extend beyond age 90, and the income payments are not indexed.
Based on their age, Jane and Joe can receive a guaranteed income stream of $3,929 per year from the life annuity. They are in a 53.53-per-cent marginal tax bracket. Since only $961.84 of the $3,929 annuity income that they would receive is taxable as income, they would pay only $514 in taxes on their annuity income and would be left with $3,415 in after-tax income, which means a 3.41-per-cent after-tax rate of return. If Jane and Joe were to receive taxable income from a bond or GIC, they would need a 7.33-per-cent guaranteed before-tax rate of return to net 3.41 per cent after tax.
Jane and Joe could then use the $3,929 annual income from the life annuity to purchase a $288,000 joint last-to-die universal life insurance policy. If Jane and Joe name one or more charities as the beneficiary of their life insurance policy, upon the death of the last spouse, the $288,000 would be considered a charitable donation by the estate of the last person to die and would generate approximately $144,000 in charitable donation tax credits.
Therefore, by using this strategy, Jane and Joe would be able to leave a $288,000 bequest instead of a $100,000 bequest. Also, since their estate would receive a $144,000 charitable donation tax credit, considering that they had initially used $100,000 to purchase the joint life annuity, the value of their estate for their children would not only decrease but it would actually increase by $44,000. Compared to leaving a cash bequest for the charity – which would reduce their estate for their children by $50,000 – this strategy would actually increase their estate by $94,000.
Keep things private
Another benefit of this strategy is that since you are making your charitable gift outside of your estate, you can give privately. This means that only you and your beneficiaries will know about your gift. You will have the choice to let others know about your gift if you wish. Remember that your will becomes a public document after your death; anyone can request a copy of your probated will and see who you left your inheritance to.
Insurance gifts are also creditor-proof. And they usually are processed rapidly (within two to three weeks of the receipt of the death claim by the life insurance company) and will not get caught up in court battles, whereas bequests in wills often do, may take years to pay out and are subject to the claims of creditors.
In addition, when you name a charity the beneficiary of your life insurance policy, your bequest will not be subject to probate fees or any other taxes. Probate fees could be as high as 1.5 per cent of the value of a gift left in a will, which means that you can achieve substantial savings by naming a charity the beneficiary of your life insurance policy.
While the above strategy can work very well in certain circumstances, the numbers may not work as well depending on factors related to age, tax bracket and marital status. Therefore, you should consider a customized version of this strategy to see if it makes sense for you.
Tina Tehranchian, MA, CFP®, CLU®, CHFC®, MFA-PTM (Philanthropy) is a FP CanadaTM Fellow and a Senior Wealth Advisor at Assante Capital Management Ltd. in Richmond Hill, Ont. She can be reached at (905) 707-5220 or through her website at www.tinatehranchian.com. Assante Capital Management Ltd. is a member of the Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada. Before acting on any of the above, please make sure to see a professional advisor for individual financial advice based on your personal circumstances. The opinions expressed are those of the author and not necessarily those of Assante Capital Management Ltd. Insurance products and services are provided through Assante Estate and Insurance Services Inc.
