GIFTS THAT ENHANCE YOUR INCOME - PART B

by Mark A. Zlotnik, CA, CLU

Charitable Insured Annuities

This article is the second in a series on how seniors can enhance their after tax income through charitable giving. One method that many seniors have been using to increase their after tax income without taking risk is by purchasing an "insured annuity" or "lifetime term deposit". This type of transaction blends the features of life annuities and life insurance to result in a transaction that provides higher after tax cash flows than GIC's or other fixed interest investments without increasing risk.

An insured annuity works as follows:

  1. A life annuity is purchased which provides a monthly income during the life of the annuitant. Payments on the life annuity stop at death.
  2. A life insurance policy is purchased which replaces the capital invested in the annuity tax free at death.
  3. Income on the annuity is taxed as a blend of interest and capital. The actual amount of taxable income is calculated on a preferred basis.

The pre-tax equivalent yield for a senior investing in this type of transaction can be significantly higher than a GIC. Pre-tax equivalent yield is the interest that someone would have to earn on a GIC-type investment to result in the same amount of after-tax cash flow as the individual would receive under an insured annuity. For example, a male aged 75 in a 50% tax bracket could earn a pre-tax equivalent yield of about 9.5% on an insured annuity based on current rates. Table A shows pre-tax equivalent yields for insured annuities.

If an individual has a desire to benefit a charitable organization, as well as a desire to enhance their income without taking risk, the insured annuity concept can be expanded. A charitable insured annuity is the same concept as an insured annuity except that the capital, instead of going back to the individual's estate, goes to the charity. Ownership and beneficiary of the life insurance policy to replace the capital is transferred to the charity. This allows the charity to issue a donation receipt for the amount of all premiums paid on the insurance policy. The affect of this additional tax savings on an individual's after tax cash flow can be significant. For example, for a 75 year old male the after tax yield can be increased from 9.5% to over 15.5% if the individual is otherwise in the 50% tax bracket. Tables B shows pre-tax equivalent yields at various ages.

The increase in cash flow resulting from the charitable insured annuity can be used in other ways to either enhance the amount going to the charity or to provide for a return of all or a portion of the capital to the individual's estate. The after tax cash flow in this type of transaction can be structured to be higher than what is available currently with a fixed income investment. At the same time more capital is created between the individual's estate and the charity that the individual wants to benefit at death.

In summary, an insured annuity can increase a senior's after tax income without risk. A charitable insured annuity can enhance income even further.
TABLE A
Insured Annuity 50% Tax Rate
Pre-Tax
Equivalent Yield
Male 65 8.1%
  70 8.6%
  75 9.5%
     
Female 65 8.0%
  70 8.4%
  75 8.9%

TABLE B
Charitable Insured Annuity 50% Tax Rate
Pre-Tax
Equivalent Yield
Male 65 11.4%
  70 13.1%
  75 15.5%
     
Female 65 10.5%
  70 11.8%
  75 13.7%