Tax Changes Highlight Value of Philanthropic Planning

The Accidental Philanthropist® – Mark Halpern

Tax changes highlight value of philanthropic planning

 By Mark Halpern, CFP, TEP, MFA-P

On June 25, 2024, the capital gains inclusion rate rose from 50 percent to 66.67 percent for individuals’ realized capital gains over $250,000 and corporations’ and trusts’ realized capital gains from the first dollar. And this is just one of several recent tax changes that have been eroding tax planning opportunities previously leveraged by high-net-worth families, including the substantive Canadian Controlled Private Corporation (CCPC) rules, which restrict the tax advantages of offshore corporations, as well as amendments to prevent surplus stripping (converting a corporation’s dividends to capital gains) without a genuine intergenerational transfer of the business.

Only four major tax-favoured strategies remain within the Income Tax Act:

• The principal residence exemption, which allows Canadians to sell the home where they live without paying capital gains tax
• Tax-Free Savings Accounts (TFSAs), allowing Canadians to save up to a maximum amount a year ($7,000 in 2024) that can grow and be withdrawn tax-free
• Lottery winnings, which Canadians can receive tax-free
• Permanent Life Insurance, which lets Canadians accumulate tax-exempt growth with no restrictions on the amount invested

I often say that people with investments outside these four strategies must love the Canada Revenue Agency very much, because they’re willing to hand over between 27% and 70% of their good fortune in taxes. Of those four, permanent Life Insurance is the most flexible tool for Canadians who want to mitigate tax, preserve wealth and maximize charity.

On the surface, of course, Life Insurance serves the needs of people who want to make sure their loved ones aren’t left with debts and have enough to sustain their lifestyle when the insured person passes away. High-net-worth families often dismiss using Life Insurance for this purpose since they assume they already have enough money to cover debts on death and their family’s lifestyle costs.

Life Insurance is also often used to cover the tax bill due when the second spouse dies – because most assets can roll over to a spouse tax-exempt – or when a single person, widow or divorcé dies. It is a cost-effective way to manage the tax expense and can be funded out of cashflow, by moving taxable assets into a tax-exempt policy, or by using financing strategies to create a cashflow neutral structure.

There are also strategic ways to use Life Insurance to get more money growing on a tax-favoured basis – whether someone is an employee, has a professional corporation or owns a business. Essentially, the policy becomes like a no-limit TFSA with money flowing into it from personal or corporate assets, growing tax-exempt, accessed tax-exempt and creating a virtually tax-exempt legacy.

Life Insurance can even convert corporate dollars into personal dollars. Let’s say $10 million is inside a corporation. When withdrawn or at the time of the owner’s death, the tax bill will be about 50 percent, or $5 million. When Life Insurance is paid for and owned by the corporation, with the corporation as the beneficiary, the proceeds on death are credited to the capital dividend account (CDA) and can flow out of the corporation tax-exempt.

Using Permanent Life Insurance for Philanthropy

All of that said, one of the best uses of Life Insurance is philanthropic. A charitable donation can mitigate up to 75% of net taxable income while someone is alive (with any excess carried forward for up to five years) – but it can mitigate up to 100% of net taxable income in the year of death and the year before death. In the context of yet another tax change that adjusted rules around the alternative minimum tax (AMT), it’s important to note that the AMT does not apply in this situation.

Permanent Life Insurance can effectively turn taxes due on an estate into a legacy-building contribution to a foundation, donor-advised fund or direct gift to charity. One family we work with has a net worth of $50 million and a projected $10 million estate tax bill. Without further planning, beneficiaries can expect to receive $40 million. They could have bought a $10 million Life Insurance policy to cover the tax bill – but they’re generous and they also understand that every $2 they bequeath to charity will save their estate $1 in tax. So, they bought a $20 million Life Insurance policy with the proceeds to be donated to charity. That $20 million will create a charitable receipt that completely offsets the projected $10 million estate tax bill. Now, beneficiaries will receive $50 million instead of $40 million – and the family’s favourite causes can put $20 million to work for good.

We work with another family that had $2 million in appreciated securities held within a corporation. The adjusted cost base was $1 million, so they were facing a capital gains tax bill of $270,000 under the pre-June 25 capital gains inclusion rate – but $360,000 after the tax change. This family, too, was charitably minded. So, they donated the $2 million in appreciated securities to a donor-advised fund. That eliminated the capital gains tax bill and gave them a charitable receipt for $2 million, offsetting $1 million in other tax due. However, they also wanted to leave a legacy to their children, so they applied their tax savings towards a $2 million Life Insurance policy to replace the donation they had made to charity. Now, the children will receive more than they would have and the charities supported through the donor-advised fund will receive $2 million.

There are countless tax-mitigating, wealth-preserving and charity-maximizing ways to use the tax-favoured status of permanent Life Insurance. The key is to focus on planning rather than products and to seek out expertise in comprehensive estate planning and strategic philanthropy to make the most of these opportunities. We collaborate with professional advisors across the country because we recognize no one can be all things to all people and a team is stronger than any one person. To implement optimal strategies, donors need a lawyer, an accountant, and professionals specializing in insurance, investment and philanthropic planning – and all parties need to be speaking with each other. With the right team in place, anyone can do good, do well and go from success to significance.

We work with many charitable organizations, from very small to very large, helping their donors and professional advisors structure generous gifts in the most tax-effective and cost-effective ways. In many cases, using the same dollars, we can magnify their generosity to create more impact. Our corporate goal is to create a national network of 100 professional advisors and charities, where each of us create $10m per year.  That’s $1 Billion of annual charity creation and it’s very realistic.  Reach out to join us for additional details.

Please do not hesitate to contact me for a no-obligation conversation to see how we can help you and your organization too.

MARK HALPERN is a well-known CFP, TEP, MFA-P (Certified Financial Planner, Trust & Estate Practitioner, Master Financial Advisor – Philanthropy). He writes this column exclusively for each issue of Foundation Magazine.