Canada Life’s Tax and Estate Planning Group (TEPG) is a resource that can help you win cases and help your clients’ insurance work as planned from both a tax and estate-planning perspective. The following is a recent example that shows the value the TEPG brings to the table.

An advisor asked a member of the TEPG team to review his client’s estate planning documents, which were set up by the client’s lawyers. Here’s what happened.

What did the client want to accomplish?

The client is a high-net-worth individual who personally owned a participating life insurance policy. One of the purposes of purchasing the policy was to provide a legacy to his three children and to fund a significant charitable gift to a favourite charity. The client’s lawyers set up his will so that on death, the insurance proceeds would be received by a testamentary insurance trust. Regarding the gift, the terms of the insurance trust stated the “trustees shall pay” the charity the difference of $1,000,000 and the total amount the client donated to the charity during his lifetime.

(As background, the client wanted to give a total amount of $1,000,000 to the charity, so the gift on death would be dependent on how much he gifted to it during his lifetime. To date, the client has donated $400,000, so the potential post-mortem gift could be $600,000.)

What was the issue that needed to be solved?

The client's lawyers were mainly concerned about avoiding probate taxes on the death benefit. As a result, they wanted to use an insurance trust, instead of the estate, to facilitate the gift to the charity, based on the donations the client made to it over his lifetime. But the lawyers’ efforts to plan around probate tax caused them to miss income tax issues relating to the charitable gift.

What was wrong with the proposed arrangement?

The TEPG team identified two significant issues with this arrangement.

First, a trust’s gift to a charity needs to be discretionary for the payment to be eligible for a charitable tax credit (note: this rule doesn’t apply to donations from a graduated rate estate “GRE”). The language in the insurance trust referring to “the trustees shall pay” and referencing a formulaic amount to pay the charity does not afford the trustees any discretion. The Canada Revenue Agency (CRA) could argue –and they have in other situations – that such a payment to the charity isn’t a ‘gift’ that’s eligible for a donation tax credit, but rather a ‘capital distribution’ to a trust beneficiary. As a result, the client could miss out on their donation tax credit.

Second, even if the donation tax credit was available, would it be of any use if it’s trapped in the insurance trust? The insurance trust won’t have enough income to use the donation tax credit. There’s no mechanism to allocate the donation tax credit to either the client’s GRE or his terminal return. In this case, the client had a significant tax liability anticipated at death and needed the donation tax credit to be available in his terminal return.

The TEPG team explained these issues to the advisor, and he raised them with the client’s lawyers. The lawyers came back with another proposed solution. The insurance trust would receive the death benefit and then transfer the amount intended for the charity to the client’s GRE. The donation would then come from the GRE. This planning alternative also caused the TEPG team some concerns.

The concern this time stemmed from rules around donation tax credits. Property gifted from a GRE must have been acquired by the GRE “on, and as a consequence of, the death”, or substituted property, for it to be eligible for a donation tax credit. The client was relying on the donation tax credit to help offset taxes on his terminal return. Since the funds the GRE would use to make the gift under this new arrangement came from an insurance trust, the GRE wouldn’t have acquired the gifted property “on and as a consequence” of death. As a result, the payment to the charity wouldn’t be eligible for a donation tax credit.

What was the outcome?

The advisor raised this issue with the client’s lawyers and eventually the solution we landed on was adding the charity as a beneficiary of the life insurance policy so it would receive a portion of the death benefit. The amount of death benefit the charity would be entitled to would change should the client make further gifts to it over his lifetime. This solution achieved the dual goals of helping to avoid probate taxes on the death benefit and having the GRE and terminal return benefit from any donation tax credit generated from the gift by beneficiary designation.

The TEPG team is ready to help you on cases like this and many others. If you have any questions, please reach out to our wholesalers.