Case Study: A Bequest
Bob and Mary are in good health, have sufficient wealth to support their lifestyle, are not concerned about their kids financial affairs and own a small successful business in Alberta. They are charitable in nature and want to help their church’s long-term survival through a significant gift to be invested with the income used to support the church’s activities (e.g. an endowment).
Without first consulting their financial advisor, they established a residual bequest of $1 million in cash to the church. When they both are gone, the $1 million tax receipt will save them $500,000 in taxes. Therefore the after-tax cost of the gift at their death will be $500,000. But is that the whole story?
Assume Bob and Mary pay 19.92% tax on dividends received from the company.
What possible sweeteners could be considered?
Had Bob and Mary consulted their financial advisor, the following scenarios may have been rolled out for consideration:
- Keep the current plan of gifting $1 million cash as a bequest. The cash would be derived from existing assets at the time of their death, or
- Keep the current plan of gifting $1 million in cash as a bequest, but fund that bequest using a 12 pay life insurance owned personally with the church as the beneficiary, or
- Keep the current plan of gifting $1 million in cash as a bequest, but fund that bequest using the same insurance policy owned corporately.
Using an interest rate of 2 percent over the 12 year life expectancy of the couple, consider the following:
The after-tax cost today of Option 1 is $394,246 ($500,000 net cost of the gift discounted 12 years at 2 percent).
In Option 2, if the couple is paid $46,545 annually ($37,200/(1-.1992)) in dividends to generate the after-tax $37,200 premium cost over the 12 years. The cost of that 12 year dividend stream in today’s dollars is $502,074 less the $394,246 in the tax savings equals $107,828 in after-tax cost to gift the same $1 million using life insurance owned personally.
In Option 3, the cost of the Corporation paying the $37,200 premium over 12 years (ignore deductibility of the premiums) at 2 percent equals $401,270. Upon death of the insured, the $1 million is paid tax free to the Corporation, and then paid out tax-free of the capital dividend to the deceased’s estate. The estate then makes the $1 million gift to the church and the $394,246 in present value tax savings is generated to the deceased. If the Corporation paid the $401,270 today to Bob and Mary as a taxable dividend, they would have $323,025 ($401,270 X (1-.1992)) in after tax cash compared to $394,046 in cash from the tax saved from the gift.
When considering gift through personal corporations, a great deal of financial and accounting expertise is involved. Donors are strongly advised to consult their advisors prior to considering any gift strategy, much less one using a personal corporation.Used with permission of the author DeWayne Osborn, Lawton Partners. Example assumes an Alberta resident donor with a top individual tax rate of 39%. Print PDF