If you want to donate money to charity and you are planning your estate, what is the best way to do it? There is an option to donate to charity each year or as a lump sum upon death. At the time of death, there are options to donate to charity as part of your will, through a life insurance policy, or by donating assets. There are considerations to keep in mind when making these choices:
What is my income level and what do I need for my lifestyle, now and on the day of my death?
If you have a high annual income (high would mean you pay the highest tax rates) and you don’t need this money for day-to-day expenses, it may be a good idea to give to charity during your lifetime. You can make this decision any year if your income fluctuates, or if you have a year where income peaks, such as a year when a property is sold or capital gains are harvested on investments. There would be a trade-off between lowering the current tax rates and lowering the estate tax rates. You might also want to consider how quickly you want to give to charity and whether you want to see how your money is used.
There are many personal opinions that come up regarding charity and how it should be done, so some introspection is required to ask yourself what your preferred way of giving would be. It’s a good idea to ask your favorite charities how they’d like their donations — lump sum versus frequent, and equity versus cash. Some charities have a hard time handling large sums of money because they may not have the facilities to allocate it where they need it. Other charities may receive unpredictable funding from other sources if large amounts of money are donated, which would disrupt their cash flows. Depending on the type of donation, a charity could use it for different purposes and this would make it easier to use the donations.
If I give donations at the time of my death, how should I do it?
Donate your RRSP
What about donating RRSP, RRIF or LIRA accounts to charity? Why are you doing this? These accounts can be heavily taxed depending on your income on the day of death and the remaining balance on the day of death. This strategy is similar to gifting stock with large unrealized capital gains upon death that could be wiped out if the stock were donated to charity prior to sale.
Donate through your will
The downsides are that the will can be contested or changed, which can affect the intended outcome of donating to charity. There are also probate fees that apply to anything that passes through a will.
Donation of life insurance through a will
This donation is made upon death. Please note that donation is made through the estate and at the time of death. Note that “cultural gifts” and “environmental gifts” are taxed differently. Gifts may be claimed: in the tax year of the estate in which the gift was made, a previous tax year of the estate, or one of the individual’s last two tax years up to 100% of net income. The estate can also carry endowment credits up to 5 years into the future if it is Graduated Rate Estate (GRE) or 10 years for environmentally sensitive land. Note that a gift given through a will or through the estate is treated in the same way. The donation consists of a lump sum and the tax certificate is made to the estate and not to the individual. There are probate fees, disclosure and the possibility of contesting the estate.
Life insurance donations by naming a charity as the beneficiary of the insurance policy
The person would not qualify for a charitable giving tax credit for the premiums paid in this case. This would be done when an insurance policy is about to renew or expire. If you let the policy expire by not paying premiums, you may not get any value for it or you may get a cash surrender value that may be less than fair market value. Life insurance can be donated by 1) changing the charity as beneficiary and upon death. The estate would receive a tax credit based on the amount of the gift. Another way is to 2) change the ownership of the policy and beneficiary to the charity. The charity should be consulted as to whether they would accept this type of gift. This method is useful for direct donations as opposed to using third parties. Can the donation credit be used? It is worth up to 75% of net income with a 5-year carryover.
Life insurance donations directly to charity
In case 2) the fair market value is used, which is generally higher than the cash surrender value. Who pays the premiums if the insurance is donated? The insured may continue to pay premiums and receive additional tax credits for the payments if they occur after the insurance policy has been transferred to charity, or the premiums may be deducted from the cash value of the policy. Other donors of the charity can also pay the premiums themselves. The charity may prefer to pay the premiums because if the donor agrees to pay the premiums and fails to do so, the insurance policy will lapse. Keep in mind that the characteristics of the life insurance policy should be checked thoroughly to make sure you arrive at the correct fair market value. In the second case, there are no probate fees, no disputability of the estate and no problem with creditors and the estate. This case may apply to a new or existing life insurance policy during your lifetime. The rest of the estate can be kept whole for the other heirs. Gifting a life insurance policy can be cheaper than a cash gift because investment income is generated within the life insurance policy. Note that if there is a split of an insurance policy between a donor and a charity, the CRA will not want an advantage in favor of the donor. The benefits to the charity and the donor must be clearly separated, otherwise the charitable tax deduction would not be allowed. The person making the gift must calculate the value of the split – which will likely be done with the help of an insurance underwriter or actuary.
This method donates assets in kind when there is an unrealized gain or loss embedded in the transaction. This is called donating assets and the total donation limit is increased by 25% of the taxable capital gain. The donor can designate a value between the ACB (Adjusted Cost Basis) and the FMV (Fair Market Value) of the donated property for the calculation of the capital gains and tax credit. If an insurance policy is purchased to replace the value of the donated asset (and offset the tax consequences of a capital gain), the tax savings from the gift can be used to purchase the insurance policy.
Donor-advised funds and foundations
A donor advisory fund is an endowment fund. Money is deposited into the fund and the fixed payout is made to registered charities. There is flexibility regarding when donations are made and to whom they should be made. This can be used as a charitable legacy as the donations can be continued after death and can also be your heirs. The money is donated to an organization that invests the initial donation, records where the proceeds are donated, invests the money under your direction, and issues the tax bills.