The Spirit of Giving
We are well into the holiday season and you may be thinking of gift ideas for your family and friends. Charities also reach out to you in the last months of the year. In the spirit of giving, let’s explore how donating to a registered charity benefits both the charity and reduces taxes owing.
I recently met with a client who donates a great deal of money to charity. As she approaches her elder years, she is struggling with having to reduce her donations to protect her income for her own living expenses which may increase if she goes into a retirement home. Beth is 85 years of age and has strong convictions about giving to less fortunate people, especially children in war-torn countries. I’ve had to remind her that she has given much over the years and needs to think more about herself now.
There are many ways to make donations and reduce taxes as a side benefit of our generosity. This is true both during our lifetime and at the time of passing. Most of us are already familiar with the tax credits we get from the CRA when we give money to eligible charities*. However, take note of these two important points:
- The tax credits available do not fully offset the amount donated, so there must clearly be a charitable motive underlying the gift.
- The CRA limits the amount of the credit to no more than 75% of the donor’s net income for tax purposes for the taxation year.
In relation to Beth and similar clients, they pay little income tax because of the substantial amounts they donate to the causes that matter to them. They are often single and childless and have a good income that affords financial security. People like Beth and another client I’ll call Warren, also make use of annuities for charitable giving. A charitable gift annuity combines a charitable gift with an insurance contract that provides regular payments to the donor in exchange for a lump sum payment.
Warren has two such contracts; this is how a charitable annuity works. He contracted with the charity and donated the funds for them to buy the annuity. They got to keep a portion of the funds for immediate charitable work and purchased an annuity which flows income to Warren for life. He received an immediate tax receipt for the gift amount, and is provided with a guaranteed payment each year though the insurance contract. The income from annuity is largely tax exempt and does not result in a reduction of Old Age Security (OAS). As the annuity is no longer part of his estate, it will not be subject to probate fees.
Another way you can donate to charity is to transfer ownership of “permanent” life insurance policy to a charity and to name the charity as the beneficiary. You may continue to pay the premiums or have the charity pay them. For tax purposes, there is an immediate tax credit for the amount of the cash surrender value of the donated policy plus any accumulated interest and dividends that are also assigned (less any outstanding policy loan). If you continue to pay the premiums, or contribute the funds to the charity so that they can pay them, the premium payments will be treated as additional charitable gifts and deductible tax credits ensue.
Another option is to donate the insurance proceeds through a will. This can work in two different ways:
- You name the estate as the beneficiary of the policy and include a gift to charity by will equal to the amount of the life insurance proceeds. When the insurance proceeds are paid to the estate, and the bequest is paid to the charity according to your will, your estate will receive a donation receipt which will create a large tax credit, thus reducing the taxes payable by the estate.
- You can name the charity as the beneficiary of the life insurance proceeds and the proceeds will be paid directly to the charity. These proceeds are then again considered to be a charitable gift made by the deceased and a tax credit ensues.
You may also designate a charity as the beneficiary of a registered plan such as RRSP, RRIF or TFSA. Yet again this option allows the proceeds to pass to the charity outside of the estate, eliminating probate fees on the proceeds.
Executors have flexibility to allocate donation tax credits among:
- The year the gift is made by the estate
- The final two years of the deceased
- Any five years after the gift is made
If this season causes you to consider making significant donations to your favorite charitable causes, it is worthwhile to consider different strategies. I am happy to consult with you and your tax professional. As always, you can reach me at 416-939-2000 or firstname.lastname@example.org.
It’s just good advice.
*It is advisable to review with a professional if the intended recipient organization or institution is an eligible charity for the purposes of the donation tax credit.