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Insured donation strategies

Brenda McEachern, BComm, LLB, TEP


Wealth & Tax Planning Consultant
BC Product Solutions Centre

September 26, 2017


Important considerations

This material is for informational purposes only and should


not be construed as legal or tax advice. Reasonable effort
has been made to ensure its accuracy, but errors and
omissions are possible.

All comments related to taxation are general in nature and


are based on current Canadian tax legislation for
Canadian residents, which is subject to change.

For individual circumstances, consult with legal or tax


professionals.
Perspective

Allied professionals
Taxes are the problem, gifting is the solution

Charities and donors


Gifting is the goal (problem), planning is the solution

3
Perspective

Traditional planning creates tax credit to offset tax liability


Matches timing of gift with tax exposure

Alternative planning uses insurance to pay tax liability

Creative planning combines both solutions


Solve the problem twice
Deliver exponential benefits

4
Donation Decision Tree

WHO should be the donor?


WHAT should be donated?
WHEN do we want the deduction?
WHO should be the donor?

Who has the means / assets / money?


Individual
Corporation
Estate
Who has the ability to fully utilize the donation receipt?
Taxable income stream
WHAT should be donated?

Cash

Zero capital gain inclusion rate assets:

Publically traded securities


Share / unit of mutual fund corporation / trust
Ecologically sensitive land
Cultural property
Private company shares
Insurance
WHEN do we want the deduction?

Current tax liability


Sale of business / real estate / portfolio
Estate Tax liability
Private corporation
Real estate
RRIF
Non-registered portfolio
Match the donation receipt against the tax liability
WHEN do we want the deduction? Insurance

Owner Beneficiary Donor Receipt Charity

Each year based


Cash received
Charity Charity on annual
at death
premiums

At death based on Cash received


Donor Charity
death benefit at death
Insured donation strategies

Strategy 1: Gift Some Sell Some


Strategy 2:
Strategy 3: The Double Double
Strategy 4: Gift the RRIF
Strategy 5: Put the Cookies Back in the Jar
Strategy 6: Estate Freeze Shares
Strategy 7: Leveraged Corporate Estate Gift
Strategy 1

Gift Some Sell Some


#1 Gift Some Sell Some

Mark has a block of shares he bought for $180,000


Theyre now worth $300,000
Owned in his corporate portfolio
MarkCo is going to sell before yearend to lock in the gain
Corporate tax payable is ~$30,000

Mark is planning to make a $50,000 gift personally


#1 Gift Some Sell Some

Make the gift corporately instead

Sell $250,000 and gift $50,000 in kind


Gift in kind triggers no capital gain on the $50,000
Gift in kind creates Capital Dividend Account = CG
Gift in kind creates donation receipt = $50,000 FMV

Donation receipt offsets full tax payable on the sale


#1 Gift Some Sell Some

Gift Sale Total


Proceeds 50,000 250,000 300,000
ACB -30,000 -150,000 -180,000
Gain 20,000 100,000 120,000
Taxable CG 0 50,000 50,000
Donation -50,000 -50,000

Taxable Income -50,000 50,000 0

Corp Tax Payable 0


#1 Gift Some Sell Some

Gift Sale Total


Net Proceeds 0 250,000 250,000
CDA 20,000 50,000 70,000
Capital Dividend 70,000
Personal Tax Payable 0
Net Net Corporate 180,000

Net Net Personal 70,000

Net to Charity 50,000


Strategy 2
Strategy 3

The Double Double


#3 The Double Double

Donor makes annual gift (#1)


Donor uses tax savings to purchase a life insurance
policy to make an estate gift (#2)
#3 The Double Double

Ryan is 45 and has done very will in mining

He is considering pledging $130,000 annually for 20


years for a total commitment of $2.6 million

His annual tax savings will be ~$60,000

He could use this to create a second estate gift

How much insurance will $60,000 x 20 years buy?


#3 The Double Double

45 male, non-smoker, standard risk


$3.6M Universal Life, Limited 20 Pay cost of insurance

Ryan is owner
ABC Foundation is beneficiary
Annual premium payments are not deductible
(the original $130,000 annual donation was deductible)
Estate receives $3.6M donation receipt equal to the
death benefit
Offsets tax owing in on his terminal return, year prior
and any prior year of the GRE.
#3 The Double Double

Ryan must earn at least $175,000 to absorb the full


annual donation of $130,000
Ryans estate needs taxable income and taxable gains
to absorb the $3.6M donation receipt

$6.2M total gift ($2.6M lifetime + $3.6M estate)


$2.9M total tax savings ($1.2M lifetime + $1.7M estate)

$2.6M out of pocket ($130,000 x 20 years)


Strategy 4

Gift the RRIF


#4 Gift the RRIF

Clients have choices when distributing their estate:

HEIRS CHARITY
YOUR ASSETS

CANADA REVENUE AGENCY


#4 Gift the RRIF

John and Trish are 65 and 60


They have $1M RRIF they will never need
They have $1M GIC and other miscellaneous assets

At life expectancy, the RRIF is projected to be $1M


On the death of the survivor, tax on the RRIF will be
~$500,000
#4 Gift the RRIF

Do Nothing + Insurance + Gift


RRIF 1,000,000 1,000,000 1,000,000
GIC 1,000,000 1,000,000 1,000,000
Insurance 500,000 500,000
Gift RRIF 1,000,000
Total Assets 2,000,000 2,500,000 2,500,000
Net to CCRA 500,000 500,000 0
Net to Kids 1,500,000 2,000,000 1,500,000
Net to Charity 1,000,000
Strategy 5

Put the Cookies Back in the Jar


#5 Put the Cookies Back in the Jar

Tim and Jennifer are 60, physicians, in good health


They have a $2M stock portfolio and other assets
They have been approached by their local hospital
regarding a major funding campaign to expand the
neo-natal department
They would consider a $500,000 lump sum gift this
year but are hesitating because it will reduce their
childrens inheritance
Ideas?
#5 Put the Cookies Back in the Jar

Tim and Jennifer gift from their portfolio today


They use the net tax benefits to purchase a life
insurance policy to replenish the estate for their
children
Charity receives the securities in kind and
converts them to cash for their neo-natal campaign
#5 Put the Cookies Back in the Jar

Gift of public securities to charity


Securities includes stocks, bonds, mutual funds,
segregated funds and stock options
Excludes flow-through shares

Capital gains inclusion rate reduced to nil


Significant tax incentive for funding major gifts
#5 Put the Cookies Back in the Jar

Fair Market Value $500,000


ACB $100,000
Gain $400,000
Taxable Gain NIL

Donation $500,000
Donation tax credit (50%) $250,000
Life insurance policy Lets see

What will $25,000 x 10 years buy?


#5 Put the Cookies Back in the Jar

Number of Total annual ADO portion of


Product Initial face amount
premiums premium deposit
Estate Achiever 20 (EA20)
10 $25,000 $12,444 $369,359
with ADO, PPLD
Estate Achiever 100 (EA100)
10 $25,000 $14,274 $338,737
with ADO, PPLD
Universal Life limited 10 pay
10 $25,000 NA $743,000
GIO 10 year 1.5%

DB comparison at year 30
$880,000
$860,000 $853,739
$841,470
$840,000
$820,000
$800,000
$780,000
$760,000 $745,483
$740,000
$720,000
$700,000
$680,000
EA 20 ADO EA 100 ADO UL - LP10
#5 Put the Cookies Back in the Jar

Number of Total annual ADO portion of


Product Initial face amount
premiums premium deposit
Estate Achiever 20 (EA20) with
20 $25,205 $12,546 $372,391
ADO, PPLD
Estate Achiever 100 (EA100)
25 $25,205 $14,392 $341,518
with ADO, PPLD
Universal Life limited 10 pay
10 $25,205 NA $749,000
GIO 10 year 1.5%

DB comparison at year 30
$880,000 IRR: 4.90%
$860,000 IRR: 4.84%
$840,000
$820,000
$800,000
$780,000
$760,000 IRR: 4.35%
$740,000
$720,000
$700,000
$680,000
EA 20 ADO EA 100 ADO UL - LP10
#5 Put the Cookies Back in the Jar

Donation $500,000
Donation tax credit (50%) $250,000
Life insurance policy initial death benefit* $338,737
Tax-free death benefit at year 30 $853,739
Equivalent growth rate needed on shares 2.7%
(tax rate 50%)

*EA 100, ADO, JLTD, premium $25,000,offset from year 11


#5 Insured estate replacement (during life)

Benefits
Donor makes a substantial donation today and can
offset current tax liabilities immediately
Charity receives substantial donation today
Family receives recognition for the gift today
Donor funds estate replacement insurance using net
tax benefits
Donors estate receives total death benefit funded by
the donation tax benefits
Strategy 6

Estate Freeze Shares


#6 Estate Freeze Shares

Patrick and Anne own shares of a private corporation


They complete (or have completed) an estate freeze
under which they own fixed-value preferred shares and
their children own common shares
Patrick and Anne are working with their advisors on a
succession plan, part of which is to decide what to do
with the preferred shares after their death
#6 Estate Freeze Shares

Parents Kids
Preferred shares Common shares

FMV = $2M FMV = $1


ACB = $0 ACB = $1
PUC = $0 PUC = $1

Corporation
#6 Estate Freeze Shares

Proposal
Parents wills revised to direct estate trustee to donate
50% of the preferred shares to charity and leave the
other 50% of the preferred shares to their children
Corporation purchases $1,000,000 life insurance on
parents (joint last to die)
On death of surviving spouse, charity receives $1M
preferred shares
Corporation uses the life insurance proceeds to
redeem the shares from the charity
#6 Estate Freeze Shares

Results :
Charity receives $1,000,000 cash after redemption
Corporation retains $1,000,000 CDA (assume nil ACB)
Children receive $1,000,000 preferred shares

$1,000,000 donation receipt available on terminal tax


return
Eliminates tax payable on the deemed disposition of the
freeze preferred shares on death
No tax payable by the charity on the redemption of shares
#6 Gifting of private company shares

Results on death of surviving parent:


Capital gain on final T1 $2,000,000
Tax (50% of taxable capital gain) $ 500,000
Donation (50% of preferred shares) $1,000,000
Donation tax credit (@ 50%) $ 500,000
Death benefit (use to redeem donated shares) $1,000,000
CDA retained in corporation $1,000,000
Increase in value of common shares $1,000,000
Strategy 7

Leveraged Corporate Estate Gift


#7 Leveraged Corporate Estate Gift

There are several charitable strategies that use


leveraging:
Well look at one thats structured around a strategy
called the immediate financing arrangement (IFA)
Can be done personally or within corporation

Whats an IFA?
#7 Charitable IFA

Business diverts cash flow or repositions investment


dollars into an insurance policy over a number of years
(usually anywhere from 8 to 15)
Business gets a bank loan to replace the dollars that
went into insurance:
The policy and potentially other assets are assigned to the
bank as collateral
Business pays the loan interest going forward
Business gets two tax deductions: interest and
collateral life insurance
Death benefit pays off loan, whats left over serves the
business owners insurance need
#7 Charitable IFA

Tax rules
Interest deductibility (paragraph 20(1)(c)):
Purpose test loan used for the purposes of earning
income from a business or property
Paid or payable
Legal obligation
Limited to a reasonable amount
#7 Charitable IFA

Tax rules
Collateral life insurance deduction (paragraph 20(1)(e.2)):
Assignment of policy required by lender
Lender is a restricted financial institution
Interest on loan is deductible
Lesser of premiums payable and net cost of pure
insurance (NCPI)
Prorated to amount owing as percent of death benefit
#7 Charitable IFA

Participating whole life


Collateral life insurance tax deduction still
deductible while self-funding (offset)
Not the case with UL CRA technical interpretation
2007-0241911C6
As a result, the strategy works well with our Estate
Achiever pay to 100 and Wealth Achiever pay to 100
products
Loan / CSV ratio up to 100% depending on bank
#7 Charitable IFA

Whats a charitable IFA?


A regular IFA but on death, the insurance payout to the
corporation (after the bank loan is paid) is distributed as a capital
dividend to the estate and the estate donates all or a portion of
the funds to charity
Charity gets a potentially significant donation
The estate obtains a potentially significant tax credit that can
offset income taxes payable (i.e., capital gains taxes) in the
terminal return
#7 Charitable IFA

This strategy is NOT for everyone!


Client should be:
Affluent and financially stable
A business owner or investor
Risk-tolerant
Comfortable with debt

Many banking, financial and tax considerations


#7 Charitable IFA

Bank lending considerations


Not all banks have IFA loan programs
Minimum lending prerequisites of $30,000 per annum for 10
years
Client must apply and qualify for financing
Loan / CSV ratio up to 100% (depends lender and type of
policy and investment options chosen if UL)
Additional collateral required if shortfall between loan and
loan / CSV ratio
Loan typically has no preset amortization and no scheduled
principal payments, interest paid regularly and charged at a
floating or fixed rate
Interest capitalized on a case by case basis
Many banks have annual review process
Most banks charge setup fees, potential legal costs as well
#7 Charitable IFA

Financial and tax considerations


Interest rates may fluctuate
Pay interest annually / capitalize
Performance of the life insurance policy
Change in bank lending terms / conditions
Other assets at risk
Availability of taxable income to use tax deductions
Availability of tax deductions
Changes in tax laws (legislation and case law) and
CRA interpretations
#7 Charitable IFA

During life

Purchase policy
Collaterally assign policy
+ other assets
Holdco
Loan advances = premium


Loan advances used to
(re)purchase investments or
(re)invest in business
#7 Charitable IFA

On death

Client dies Net death benefit
CHARITY
GRE
donated to charity

Net death benefit


distributed as capital
dividend (CDA required)


Holdco Policy pays off loan,
net death benefit
received by policy
beneficiary
#7 Charitable IFA (example)

Example: Donors, male 55 and female 52, their


corporation buys a $5,000,000 JLTD EA 100 life
insurance policy.

Insurance details:
Basic annual premium $119,085
Annual ADO $175,550
Total annual premium $294,635
Premium offset From year 11
DSIR 5.5%
#7 Charitable IFA (example)

IFA loan details


IFA loan interest rate 3.5%, years 1 to 5
5%, years 6+
CSV/loan ratio 90%
Peak additional collateral $735,990
Year when no additional collateral 16
required
#7 Charitable IFA (example)

Tax details
GREs tax rate 50%
Corporate tax rate 51%
Average corporate income needed to $169,353
use tax deductions
Tax savings reduce net interest costs Yes
Donation objective $1,000,000
Tax savings from donation $500,000
#7 Charitable IFA (annual outlays)

$350,000

$300,000

No IFA - annual premiums


$250,000
IFA - net interest costs

$200,000

$150,000

$100,000

$50,000

$-
53 55 57 59 61 63 65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95
#7 Charitable IFA (compare at year 40)

$16,000,000
$15M

$14,000,000
$12.5M
$12M
$12,000,000

$10,000,000

$8,000,000 IRR IRR IRR


4.7% 6.9% 7.1%
$6,000,000

$4,000,000
$3M $2.7M $2.7M
$2,000,000

$-
No IFA Standard IFA Charitable IFA
Total premium / net interest cost Death benefit / net death benefit
Conclusions

Charities need funding


Donors want to give funds to charities
The tax rules provide incentives to give
Life insurance can facilitate or enhance planned
giving for both donors and charities
There are lots of strategies!
The key is understanding a clients financial
situation, estate plans, and (especially) their
charitable interests
Questions?

Thank you for your time!