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Donations of Life Insurance: An Update

(From the July 2020 Edition of eFORUM)

By Jamie Golombek and Debbie Pearl-Weinberg

Some charities are experiencing an increased need for funding due to the COVID-19 pandemic, while at the same time finding this to be a difficult time to generate donations. While the need for short-term funding can’t be ignored, longer-term donations still play an important role in the ongoing funding of many charities. Gifts of life insurance have traditionally provided donors and charities with a tax-effective tool to make significant charitable gifts upon death. Correspondence last fall from British Columbia’s Financial Services Authority (BCFSA) put a temporary chill on such donations, but that decision was recently reversed, paving the way for advisors to reignite this important philanthropic discussion with their clients.

Types of gifts of life insurance

There are two primary ways to structure a gift of life insurance. The first is where the donor owns the policy and the second is where the charity itself owns the policy. Each has different tax consequences.

Donor owns the policy

One method of gifting life insurance is where the owner continues to own the policy, and either names the charity as the beneficiary of the policy, or makes a bequest of the death benefit of the policy to the charity through their will. Although the donor won’t be entitled to a donation tax credit for the annual premiums that are paid on the insurance policy, the donor’s estate will be able to claim the donation tax credit for the value of the death benefit. In most cases, this donation credit may be used to reduce tax in the year of death, the year prior to death, or in the estate, either in the year of the donation, a prior year of the estate, or carried forward five years in the estate.

As noted, this tax credit is available if the charity is designated as beneficiary of the policy directly, or if the estate is named beneficiary, with the proceeds gifted to the charity under the will. The former approach is recommended in most cases, as insurance proceeds paid to the estate may be subject to probate fees (in Ontario, estate administration tax), exposed to estate creditors, and in the case of contentious estates, potentially tied up in estate litigation.

Charity owns the policy

The donor may instead wish to either take out a new life insurance policy or transfer an existing policy to the charity, whereby the charity would be the owner and beneficiary. On the death of the insured, the charity will receive the death benefit under the insurance policy. Each year, the donor will be entitled to a charitable receipt for the premiums the donor paid on the policy.

If the donor already owns a life insurance policy, the policy can be transferred to the charity. The donor will be considered to have disposed of the policy at its then value, which, under the applicable definition contained in the Income Tax Act, is generally the cash surrender value (CSV) of the policy. If this exceeds the adjusted cost basis (“ACB”) of the policy, it will result in a policy gain being realized, which is fully included in income. The donor will be entitled to a donation tax credit for the fair market value of the policy, which may differ in amount from the cash surrender value, and which will usually more than offset any tax payable on the disposition of the policy. For example, it’s possible that the fair market value of the life insurance policy may exceed the cash surrender value, sometimes by a significant amount, if the donor has a shortened life expectancy.

A qualified actuary must calculate a policy’s fair market value. In certain circumstances, an anti-avoidance rule will deem the fair market value of the life insurance policy to be its ACB when the policy has been donated to a charity. This rule was originally introduced along with other changes that target tax shelter donation schemes. The deeming rule applies where the donation is considered to be part of a tax shelter. The rule will also apply where the insurance policy was acquired less than three years before the donation is made, or less than 10 years before the donation is made where it is reasonable to conclude that one of the main reasons that the life insurance policy was acquired was to subsequently make the donation.[1]

Gifts of life insurance in British Columbia

In late 2019, doubt arose as to whether life insurance policies could be continued to be donated to a charity. This stemmed from a November 2019 letter sent by the BCFSA to a registered charity indicating that if a charity accepts life insurance policies as donations, then it will be considered trafficking in insurance, which is an offence under the Insurance Act of B.C. Further, the correspondence indicated that the specific charity was not to solicit or accept gifts of life insurance from B.C. residents, and that information should be added to the charity’s website about this prohibition. As a result of this correspondence, numerous charities across Canada (i.e., not just in B.C.!) removed information from their websites regarding donations of life insurance.

Fortunately, in May 2020, the BCFSA issued an Interpretation Bulletin with the purpose of clarifying its “position on the interpretation and application of section 152 of the Insurance Act…to certain activities related to the charitable donation of life insurance policies in British Columbia.”[2] According to the bulletin, the BCFSA clarified that “solicitation by bona fide charities of donations of life insurance policies or benefits is generally not prohibited under section 152 of the Act.” In addition, it is their view that donations of life insurance by an insured directly to a bona fide charity is generally not prohibited under the Insurance Act. This includes naming a charity as beneficiary of an existing policy, taking out a new policy in the name of the charity, and transferring ownership of an existing policy to a charity. In coming to these conclusions, the BCFSA reviewed what it considered to be “legitimate charitable donation activities,” the prohibition contained in the Act, and “the likelihood that a court might find that activities are captured” by the section.

This is welcome news for both charitable organizations and potential donors of life insurance policies across Canada. Although the November 2019 correspondence of the BCFSA only commented on the insurance legislation applying in B.C., as most other provincial insurance legislation contains similar provisions, this could have resulted in a national restriction against this powerful philanthropic tool.

[1] See subsection 248(35) of the Income Tax Act. This provision does not apply to donations made on death.

[2] See BCFSA Information Bulletin INS-20-003.

Jamie Golombek, CPA, CA, CFP, CLU, TEP, is managing director, tax and estate planning, with CIBC Private Wealth Management in Toronto. Debbie Pearl-Weinberg, LLB, is executive director, tax and estate planning, with CIBC Private Wealth Management in Toronto.

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