What is a Charitable Gift of Life Insurance?

Life insurance is an effective way to fund legacy-sized charitable gifts. It usually involves naming a charity as the beneficiary of an existing or a new life insurance policy.

As a policyholder, you pay the premiums, and when you pass, the chosen organization receives the death benefit tax-free. 

Let's cover the details of how it works and if it's a cost-effective way to leave a legacy.

How does a charitable gift of life insurance work?

The primary purpose of life insurance is to provide financial security to those who you leave behind. However, you can also use it for other purposes, including a charitable donation after death. 

Churches, schools, support groups, hospitals—these and several other organizations primarily rely on donations to fund their operations. Typically, this means direct donations from people who support their cause. But you can also support a cause close to your heart by making a charitable gift of life insurance. 

So how does this work?

It involves purchasing a life insurance policy and designating a charitable organization as the beneficiary. Upon your death, the insurance proceeds will be paid tax-free to the organization you support. 

While you can use both term life and permanent life insurance for making a charitable donation after death, the latter is a much option. That’s because permanent life insurance, unlike term life, doesn’t come with an end date. It provides coverage for as long as you live, meaning your beneficiary will eventually receive the payout. 

You can also use a permanent life plan to make a charitable donation while still living. Most permanent life policies accumulate cash value, which the policy owner can access during their lifetime. 

Let’s say you bought a permanent life plan 20 years ago to protect your family’s future against life’s what-ifs. However, now that you have accumulated enough wealth to take care of your family upon your passing, you no longer need the coverage. Rather than surrender the policy yourself in exchange for its cash value — which amounts to $80,000 — you decide to transfer the policy’s ownership to a charitable organization.

In case future premiums are needed to keep the policy active, you could make annual contributions to the charitable organization. Alternatively, you can choose to surrender the plan for its net cash value ($80,000 less any surrender charges and other fees), partially withdraw the cash value, or take out a policy loan against it. 

Benefit of donating using life insurance

Using life insurance as a charitable gift allows you to bequeath a much larger sum than you would be able to donate otherwise. For example, a 35-year old Joe can buy $100,000 whole life insurance policy by paying around $75/month. The benefit is much greater than what Joe could donate at one time. 

By paying $75 every month to his favorite cause, Joe might not be able to make a big difference. However, putting this money towards a permanent life plan with a sizable face value allows him to make a large donation in the future. 

Types of life insurance gifts

You can use life insurance to make a charitable gift in the following three ways: 

1. Name a charity as a beneficiary

A life insurance beneficiary can be any individual or entity you choose to leave the death benefit to. This can include charities and non-profit organizations. 

You can name a charity as your policy’s sole beneficiary or split the insurance proceeds between your family and a charitable organization. What percentage of the policy amount the charity receives is entirely up to you.

2. Transfer the ownership of your policy to a charitable organization

If you own a life insurance policy and want to make an immediate contribution, you may consider transferring it to the charitable organization. Once the ownership is transferred, the charity — not you — will own the policy. The latter could name itself the beneficiary and collect the death benefit upon your death. Alternately, it could choose to collect a payout immediately by surrendering the policy in exchange for its cash value. 

3. Gift life insurance dividends

Want to support a charity on an ongoing basis? If so, you can still make contributions through your life insurance policy. 

Participating whole life insurance provides the added benefit of policy dividends. If you own such a policy, you can donate the dividends in cash to your favorite charity each year. This way you can make recurring donations without breaking your budget. You can gift life insurance dividends regardless of whether the charity is named as the beneficiary on the policy or not. 

What tax deductions apply to the gift of life insurance?

If you designate a charity as the policy beneficiary, you will not be able to claim a tax deduction on the premiums you pay. The death benefit, however, is paid tax free to the charity. 

If you transfer the ownership of your policy to a charity, you may get a tax deduction for the current year.

If you make annual gifts through a policy, you will not pay tax on dividends taken in cash until they exceed the cost basis.  

Example of a Charitable Gift of Life Insurance

Let’s say you are evaluating different options to support your two favorite charitable organizations: The Canadian Red Cross Society and Canadian Feed the Children.

Apart from making direct donations, you can purchase a permanent life insurance policy and have the death benefit split equally between the two. So you take a $500,000 permanent life plan and name The Canadian Red Cross Society and Canadian Feed the Children as your primary beneficiaries. 

Because you are the policy owner, you are responsible for keeping the policy active by paying premiums on time. Upon your death, the insurance proceeds will be divided equally between the two charitable organizations. 

You will not get a tax break on the premiums you pay, but the death benefit will be tax-free to your beneficiaries. 

Can you change the beneficiary when gifting life insurance?

When a charity is listed as a revocable beneficiary, you — the policyholder — can change the beneficiary designation at any time. A revocable beneficiary is someone whose rights to the proceeds of your life insurance can be changed or revoked. As a policy holder, you can remove a revocable beneficiary at any time and for any purpose without informing them. 

However, if you name a charitable organization as an irrevocable beneficiary, you will need its consent to change the beneficiary designation. An irrevocable beneficiary is someone who enjoys unrestricted access to the death benefit and cannot be removed from the policy without their permission. 

With a revocable beneficiary, you enjoy total control over your policy. It is usually the best course of action as it allows you to change the beneficiary designation later should you choose to. 

Conclusion

Life insurance is a flexible financial tool and can be used for different purposes, including as a charitable gift.

There are three main ways in which you can use life insurance to support your favorite charity. First, you can designate it as the beneficiary on your policy. Second, you can transfer the ownership of an existing policy to the organization. Third, you can make recurring contributions during your lifetime by donating life insurance dividends.

Considering using life insurance to support a charity? Contact a Dundas Life licensed advisor today. We're happy to go over this strategy and see if it's right for you.