How to increase cash flow and your donation to charity

Charitable Insured Annuities

Charitable insured annuities can be an attractive method of planned giving for some individuals.  This method of planned giving is most suited for individuals who are 70 and older and planning to make a significant contribution to charity.  The suitability of this option is enhanced if the individual has a low risk tolerance and currently invested in guaranteed investment certificates (GICs) or term deposits.

A charitable insured annuity is one of those strategies that is easier to look at by breaking it down into its sections.  The four steps below list the main components of this strategy and highlight some of its benefits.  Individuals best suited for these strategies generally become more intrigued by this option after they have looked at the cash flow benefits.  This method of planned giving creates an enhanced annual cash flow while providing a significant contribution to charity.

Completing the four steps below will allow an individual to determine if this strategy may be suitable for them:

Step 1: 

The first and most critical step in determining if this strategy should be considered is the individual’s ability to obtain life insurance.  For this strategy to be considered an individual must be able to qualify for the desired amount of life insurance.  If coverage is declined then the charitable insured annuity strategy cannot be a planned giving option.

With the cost of insurance in hand, the first component of the calculation is complete.  It is also important that the charity be named as the irrevocable beneficiary.  When an individual names an irrevocable beneficiary they must be certain of their choice of charity as it cannot be changed.  Once the beneficiary is determined, the annual premium costs are then considered a donation and eligible for tax credits.

Step 2:

The second step is to purchase a life annuity.  It is worth noting that the life insurance policy purchased in Step 1 and the life annuity purchased in Step 2 do not have to be through the same insurance company.  It is best to obtain a competitive quote from different companies for both the life insurance and life annuity.  Last week we touched on life annuities and how a lump sum can be used to purchase a stream of payments that lasts for the individual’s lifetime.  Although annuities are technically life insurance products they do not require the stringent underwriting that some larger life insurance policies require.  The only information that generally affects the pricing of an annuity is the applicant’s age and sex.  The older an individual is at the time of the purchase, the higher the payments will be.  This is primarily due to actuarial estimates of remaining life expectancy (which is expected to be shorter as the individual ages).

Once the life annuity is purchased it will provide a monthly payment during the life of the individual that is largely untaxed because they are taxed on the prescribed basis.  This means that each payment has a component that is a largely a return of capital, with the smaller portion being treated as interest income.  When the individual passes away the payments will stop.

Step 3:

At this stage the individual and professional advisors should be able to evaluate the strategy.  The charity is named the irrevocable beneficiary of the life insurance policy; therefore, the payments going out for the life insurance component are then considered a donation.  The cash flow coming in from the annuity is taxed efficiently.  The overall combination of these two components provides some unique benefits.

Illustration:

Mrs. Taylor is age 75 and is in the highest marginal tax bracket in British Columbia.  Through our discussion she would look to explore to option of leaving $200,000 to her favourite charity through a charitable insured annuity.  The monthly annuity cash flow that is generated from purchasing a $200,000 life annuity is approximately $1,585, of which only $234 is considered taxable (the remainder is considered return of capital).  The monthly life insurance costs are estimated at $990 per month.  With the charitable insured annuity Mrs. Taylor is able to claim the insurance costs as a donation.  The following is an estimate of the monthly cash flow for three scenarios (GIC investor, insured annuity and charitable insured annuity):

Monthly Cash Flow Analysis

monthly-cash-flow

Step 4:

When comparing the three options above, the greatest net cash flow comes from the charitable insured annuity option.  From simply a cash flow and tax standpoint it may best for some investors to consider insured annuities over GIC investments even if they have no charitable intentions.  Not every decision should be made solely for tax purposes.  The final decision should take into consideration the individual’s financial and estate plans.  Some of the other benefits of charitable insured annuities are as follows:

  • Provides for better planning (cash flows are predictable)
  • Ability to split beneficiaries (name more than one charity)
  • Ability to allocate the beneficiaries of the life insurance proceeds between charities, the individual’s estate and other beneficiaries
  • May qualify for the pension credit that has been enhanced from $1,000 to $2,000 per year in the latest federal budget
  • Bypasses will, avoids probate and public record

Individuals who consider the four steps above may realize that this is one way to increase their monthly cash flow while still leaving an intended amount to charity.  Prior to proceeding with this planned giving option, it is important to remember that the individual must first be able to qualify for life insurance.  Before implementing any strategy noted in our columns we recommend that individuals consult with their professional advisors (insurance consultant, financial advisor, accountant, and estate lawyer).