TAX AND ESTATE PLANNING
Shaping a Legacy
Charitable contributions in Canada have held steady, despite the global economic crisis. Sources say philanthropy is set for a big rebound in the years ahead, according to Michael Callahan. But are financial advisors tapping into their clients’ aspirations to leave a legacy?
For many Canadians, there comes a time to give something back. When we do well, we often feel a desire to give — it’s natural. Whether it’s a religious group, a school or educational institution, medicine, science or simply the less fortunate, many Canadians find a way to support a worthwhile cause, even in hard economic times.
According to Statistics Canada, Canadians filing taxes reported making charitable donations of over $8.6 billion in 2007, up 1.4 per cent from 2006. However, as expected, the recent economic slump has impacted charitable giving in Canada. Community Foundations Canada indicates that donations are down 37 per cent compared to last year.
But according to Brad Offman, vice-president of strategic philanthropy for Mackenzie Financial Corp, the long-term trend is up. Offman expects charitable donations to soar over the next decade. What’s more, he sees not only an increase in overall giving, but a vast shift in the way Canadians give to charity.
In the United States, about 80 per cent of charitable giving is done through advisors. Not so in Canada. Offman estimates that only 15 to 20 per cent of Canadians use a financial advisor to facilitate charitable giving, with the large majority giving to charity directly. However, he expects that number to increase dramatically over the next 10 years, approaching the 80 per cent mark in Canada as well.
“This presents a very interesting opportunity for advisors,” says Offman. “I think we’ll see a huge trend of giving through the advisory channel, as opposed to directly to charity. Advisors need to be prepared, both emotionally and technically, to face this challenge.”
The Advisor’s Role
Sure, it’s easy to write a cheque, donate old clothing or make an online donation to a charity of choice. On the contrary, more sophisticated types of giving, involving life insurance strategies, charitable remainder trusts or donor-advised funds require the services of an expert. This is a call to duty for financial professionals.
“Unlike many other aspects of financial planning, the topic of charitable giving is values-based,” says Offman. “Advisors with the strongest relationships will be in the best position.”
Unfortunately though, many financial advisors feel uncomfortable broaching the subject of charitable giving and omit it from the planning process unless the client raises the issue first. The problem is, of course, that clients are often unaware financial advisors can offer charitable giving guidance, so they don’t initiate the discussion either. Advisors beware — those who fail to relate charitable giving opportunities to the client can be sure a competitor will inevitably do so.
“Taking a proactive approach can build deeper advisor-client relationships and enhance client loyalty. It’s important that advisors be knowledgeable about the various ways charitable giving can be incorporated into financial planning and be able to present a full range of options available to a client,” adds Offman.
There are several creative solutions, in particular the use of life insurance, donor-advised giving programs and charitable remainder trusts, that advisors can discuss with philanthropic clients.
Notable DonationsCanadian entrepreneurs and business leaders have been busy in recent years in their philanthropic efforts. Here is a breakdown of some of the largest single cash donations in the country. 1. $105 million to McMaster University’s medical school 2. $100 million to the Winnipeg Foundation 3. $70 million to the Art Gallery of Ontario 4. $64 million to McGill University 5. $30 million to Royal Ontario Museum |
Use of life insurance
Many clients, and perhaps advisors alike, are often unaware of the ways in which life insurance can be incorporated into charitable giving. Life insurance solutions can provide clients with an opportunity to help a favourite charity while minimizing taxation. Some common strategies include the following.
Transfer an existing paid-up policy. This is an attractive option for clients with older policies, many of which have been fully paid up. The values of older policies have often grown substantially, due to the reinvestment of dividends, making such donations quite attractive. Clients who chose to donate an existing paid-up policy to charity will receive a charitable tax receipt for the cash surrender value of the policy.
Designate a charity as beneficiary on a new or existing policy. Of course, for existing policies, the beneficiary designation would have to be revocable in order to accommodate this change. Upon death of the insured, the designated charity receives the proceeds of the life insurance policy and the estate of the insured will receive a charitable tax receipt for that amount. The tax deduction can be applied by the estate in the year of death or carried back to the preceding year.
Transfer a new or existing policy to charity with a pledge to pay annual premiums. This is an interesting solution, providing the client with tax savings each year. The way it works is that the client will continue to pay the required annual premium, but in turn will receive an annual charitable tax receipt for the amount of that premium. Note, however, that no receipt is issued for the proceeds of the life insurance upon the death of the insured.
Designate a charity as beneficiary of an RRIF or RRSP. On the surface, this may not seem like an insurance strategy, but there is an insurance component. The client making the RRSP designation also purchases a life insurance policy of equivalent value, electing a beneficiary of choice, such as the estate. Upon death, the charity receives the proceeds from the RRSP and issues a charitable tax receipt for the donation, while the estate receives the life insurance proceeds tax-free.
Purchase wealth replacement insurance. In this case, the client would make a cash donation to a desired charity and receive the corresponding tax credit. The tax savings are then used to purchase life insurance, with the estate as beneficiary. Depending on the client’s personal situation, the tax savings can potentially fund an insurance policy adequate to replace the entire value of the gifted property.
Donor-advised programs
The donor-advised fund has become one of the most popular philanthropic tools in recent years. Created for the purpose of managing charitable donations on behalf of others, a donor-advised fund offers individuals the opportunity to establish a low cost, flexible vehicle for charitable giving.
“We establish donor-advised funds for people who want to donate a one-time sum and for those with annual giving goals. A donor-advised fund achieves all the financial advantages and personal satisfaction that comes with establishing your own private foundation, but with significantly less cost and complexity. It also means dealing with just one charity, which can then distribute to many other charities on the donor’s behalf,” says Nicola Elkins, CEO and founder, Benefaction Foundation.
Benefaction is a new charitable public foundation that works with affluent individuals and their financial advisors to develop powerful, cost-effective strategies for giving. “It is all about efficiency, control and minimizing tax burdens. We are the outsourced solution for affluent Canadians who want to give but don’t want to be burdened with administration,” adds Elkins.
Donor-advised funds are often provided by community foundations and financial services companies. Once an account is opened and designated to the client’s fund, the donor can then contribute cash or securities, usually subject to initial minimum contribution requirement of $10,000 to $50,000 depending on the foundation. The donor advises on the selection of charity and how the assets are to be invested.
A donor-advised program offers many benefits to donors:
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control and flexibility — client maintains control in terms of directing the donations to alternate charities;
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simplified administration — the sponsoring organization does the record-keeping and due diligence. Lower administration costs can make a meaningful difference, leaving more money available to charities;
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identity protection — unlike private foundations, a donor-advised program can protect a donor's identity if requested; and
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investment management — depending on the program, clients may be able to advise the sponsoring charity on how it should invest the assets.
Donor-advised giving programs present advisors with an opportunity to offer their clients innovative, cost-effective solutions and to integrate philanthropy into overall financial, tax and estate planning. “We can help advisors retain existing assets that they might otherwise lose directly to a charity and to attract new assets by offering a more holistic wealth management solution,” adds Elkins.
Charitable remainder trust
Offering somewhat of a deferred gift, yet still (potentially) presenting clients with immediate tax benefits, a charitable remainder trust (CRT) can be an effective financial and estate planning tool. Unfortunately, new tax law interpretations and a lack of clarity surrounding CRTs have made them somewhat of an ambiguous structure.
A CRT is a planned donation whereby a donor makes a gift to a charity through a formal trust agreement. Here’s how it works: the donor (settlor) transfers property to a trustee who holds and manages it in accordance with the donor’s instructions. In cases where the transferred property is income-producing, the net income is paid out to the donor and/or other named beneficiary(ies) throughout the lifetime of the trust. The trust terminates either at the death of the donor or after a specified term of years, at which point the remaining trust assets are distributed to the charity.
One of the main problems is the fact that we do not have a clear regulation of CRTs. The Canada Revenue Agency (CRA) has issued Interpretation Bulletin IT-226R, which discusses the CRA’s administrative position with respect to these structures, although the term “charitable remainder trust” is not mentioned in the bulletin. The ambiguous treatment of capital gains on transfers to CRTs is of particular concern. The CRA is unclear if the transfer can occur at cost or if fair market value (FMV) rules are applicable. Complicating matters more is the interest rate calculation of the gift receipt. Instead of providing a rate for the calculation, the CRA suggests a “reasonable rate” be used, which is open to interpretation.
Another concern is cost. There may be considerable overhead involved with CRTs, meaning they may not make sense for smaller donations. Another point worth noting is that in order to qualify for a charitable tax receipt, the contribution must be irrevocable. In this case, the client cannot have any of the capital returned. The CRA is very clear on this point — if the trust agreement allows the trustee to return any portion of capital from the trust to the donor, the gift is deemed not eligible for the charitable donation tax credit.
But there are still some advantages of using charitable remainder trusts. The donor can get a tax credit for the charitable donation now, but without entirely giving up control of the assets. And while the contribution must be irrevocable in order to achieve the immediate tax credit, the donor may have some discretion over the way the assets are invested, while still continuing to enjoy the income stream produced from the investments.
In addition to immediate tax relief, another advantage of CRTs is the ability to reduce probate fees. When the trust is created, assets transferred to the trust are removed from the donor’s estate. The assets from the trust are not a part of the donor’s will and are therefore not subject to probate fees upon death. This provides an estate planning opportunity for advisors to discuss with clients. Since establishing a charitable remainder trust often requires the services of a lawyer and an accountant, it presents advisors with another great opportunity to build centres of influence.
Philanthropy is playing an increasingly important role in financial planning and advisors need to be prepared to tackle this topic with their clients. Advisors who work with clients to help them realize a philanthropic vision are provided with plenty of opportunity to strengthen relationships with clients while working with other professionals in the community. By working together, advisors can identify creative solutions that help clients achieve their charitable giving objectives.
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New Tax Rules on Gifting Since 1996, the federal government has introduced more than 20 tax incentives to encourage charitable giving. Perhaps the biggest change came in the 2006 federal budget, which completely abolished the capital gains tax on the donation of publicly listed securities, mutual funds and segregated funds to a registered charity. Clearly this opens the door for advisors to deepen relationships with clients by discussing new strategies that were previously unavailable. If a client holds publicly traded securities or mutual funds that have increased in value, it may be more beneficial to donate those securities directly, as opposed to selling the securities and donating the proceeds in cash. The reason is that the tax normally owing as a result of the capital gain is wiped out. Furthermore, the client becomes entitled to an income tax deduction for the fair market value (FMV) of the securities donated. An example. Ms. Colleen Farrell wants to make a donation of $100,000 to the ABC Foundation, a registered charity she favours. Colleen has securities valued at $100,000 that she wants to use for the donation. Should she donate the securities directly or should she sell the securities and donate the proceeds? Let’s take a look at how each scenario pans out.*
In the end, Colleen is substantially further ahead by donating the securities instead of selling and donating the proceeds. Or in other words, the gift of securities can be made for significantly less than the net cost of an equal gift of cash. By donating stock, clients can enjoy the satisfaction of supporting a worthwhile cause of their choice while maximizing their tax benefits. |