Ten or twenty years ago, you purchased a life insurance policy. It was part of a good financial plan to keep your family protected in case of the unthinkable. Today, the mortgage is paid off, your family is grown, your retirement plan is in place and the insurance that once provided peace of mind is no longer required. What should you do with the policy?
For most Canadians, the answer is to collapse the policy. Between 85% and 88% of permanent policies never pay out a death benefit. In some cases, allowing the policy to lapse makes sense. Term policies may have no value and served their purpose. Whole Life policies may have significant cash value that you’d rather collect now. In these scenarios, the best course is frequently to relinquish the policies.
There are however other situations in which you have a valuable policy and lapsing the policy gives you little, or nothing, in return. The only benefactor is the insurance company who receives your valuable policy at no cost. Rather than providing a gift to the insurance company you should consider donating the policy to charity. The charity receives a valuable asset and you receive a worthwhile tax credit.
There are three ways to donate a life insurance policy of charity:
1. Name the charity as the beneficiary of the policy
2. Have the policy pay to your estate and have your estate make a donation to the charity
3. Give the policy to charity now, making the charity both the owner and the beneficiary
Each method has advantages and disadvantages; the best option will depend on your own circumstances. We will touch on two important tax considerations.
Premium Payments Tax Credit
Under the first two methods, you keep the policy in force and donate the proceeds upon death. The first method is typically preferred over the second, as it avoids possible taxation, probate and creditor issues in the estate. You will receive a tax credit in the year of death equal to the amount donated, but you do not receive a credit for the premiums that are paid every year.
One advantage of the third method, donating life insurance now, is that each premium payment provides you with a tax credit. The majority of charities require that you continue to pay the premiums after donating the policy.
The policy does not affect the 3% minimum distribution of assets requirement for the charity, as the policy is deemed to have nil value for that purpose. If you will pay the premiums, most charities will be happy to accept the policy and provide a donation receipt for the fair market value of the policy. For smaller charities not experienced in receiving life insurance, outside advice may be required to help facilitate the donation.
Policy Value Tax Credit
Under the first two options, the tax credit will equal the death benefit that the charity receives. The tax credit that you can use is limited to 100% of income in the year of death and the preceding year. The potential downside is that the tax credit can be a large amount which could exceed the income limit. If you will not have significant taxable gains triggered upon death, or a spouse with income to use the credit, then the tax credit will be lost.
One of the advantages of the third method, giving the policy now, is the ability to make better use of the tax credits. Rather than being limited to 100% of income over two years, you can use the credit to offset up to 75% of income in the current year, and in the subsequent five years. Additionally, the donation is made at a time of your choosing, when you know your income will be sufficient to make use of the tax credit.
The tax credit in this case is not the death benefit, as under the first two methods; it is the fair market value of the insurance policy. The fair market value of life insurance is less than the death benefit, but can be substantially higher than the cash value.
Which policies have value more than their cash value? Policies with guaranteed costs, such as level cost universal life, and term to 100 policies can have significant value, despite having low cash values. If your health has worsened since the policy was issued, then almost any policy has extra value. A fair market valuation actuary specialising in donating insurance can be consulted to help you determine whether your policy would be valuable to a charity, and how much of a tax credit you would receive.