Is Cash Value of Life Insurance Taxable in Canada?
No, But There's More To It!
Is cash value of life insurance taxable in Canada? In broad strokes no – but it’s not as simple as that. Nothing ever is.
Life insurance is a terrific tool. It provides a safety net for people who lose a loved one and an income, creates cashflow to cover final expenses and can even be used as a tax shelter.
In a nutshell it’s a must have for those of us who have debt and dependents. However it’s a complicated product that can’t be boiled down to yes and no answers.
One of the biggest benefits of life insurance is that your beneficiaries (the people you assign to receive the cash attached to your policy) get their payout TAX FREE.
So that $500K policy you bought won’t be subject to any deductions.
That said, there are some issues that you need to be aware of when it comes to life insurance and taxation because there are potential pitfalls.
My Name is James Heidebrecht, the Founder of Policy Architects
I like to introduce myself at the beginning of every article because I think the source of your information is as important as the information itself. Quite often we read articles on the web and have no idea who compiled the facts and figures.
It could literally be anyone, with any motive.
This is why I created Policy Architects. I wanted to launch a one stop shop for those of you looking for the best possible policies for the best possible price.
Knowledge is the key to making sure that happens. The more you know BEFORE you speak to an agent the more money you save.
All too often people jump into decisions without doing their homework. Once you sign on the dotted line it’s too late to rethink everything. So why not start the process out right? At Policy Architects we profit from you making sound decisions for your family.
Recommendations and continued business it the name of the game for us. So why not give us a call today. We can help you save time, money and cash.
There Are Two Types of Life Insurance &
This Matters When It Comes to the Impact of Taxes
If you are wondering is cash value of life insurance taxable in Canada – it’s important to determine what TYPE of life insurance you are talking about.
There are two different types of life insurance you can buy. Term, which is temporary income protection that is meant to cover you during your most vulnerable years. There is no guarantee that your beneficiary receives a payout so it’s VERY affordable.
To be honest term works for most people most of the time – BUT there are those of us that want to guarantee a payout and that’s where Permanent life insurance comes in.
Permanent Life Insurance provides coverage until the day you die and often includes a cash accumulation feature. THIS is where taxation can come in.
For the purposes of this article we are talking about permanent coverage.
Whether choosing universal or whole policies, permanent life insurance has the potential to be an excellent source of liquidity for estates. Clients can use these policies to create enough value in the death benefit to cover some or all of the taxes owing.
“They may not be able to avoid the tax bill,” Mr. Nelson says. “But it should take fewer dollars to fund the insurance than to pay the tax bill.”
Using life insurance as a tax-hedging strategy, Globe and Mail
Situations Where Life Insurance Is Taxable
As I mentioned above, for the most part, life insurance proceeds are delivered to beneficiaries tax free. BUT it’s important to take note that this is not always the case.
If you use your cash value creatively the taxman may still come knocking. So let’s take a look at the most common ways cash value becomes taxable.
Cash Accumulation & Surrendering Your Policy
If you buy a policy and accumulate cash value, which remains tax sheltered while you hold said policy….
…be aware that there may be tax implications if you surrender the coverage.
I am going to use an example that was in the news. A gentleman maintained $300K in coverage and paid $127,368 in premiums over 15 years. The good news is in the early years of his policy he accumulated cash which had been tax sheltered.
This man surrendered his policy and received $150,365.00. He reported $23K to the CRA (he deducted the total premiums paid).
Unfortunately the true gain was calculated by the CRA as $112,090 and this person was reassessed for $89,090. The life insurance company calculated the gain as the difference between the payout of $150,365 and the adjusted cost base which is premiums paid less the cost of the actual insurance.
Please note: If you cancel or surrender your policy and the payout is less than what you paid there will be no tax obligation.
Selling Your Policy
Did you know you can sell your life insurance policy to someone else? Yep. In Quebec, New Brunswick, Nova Scotia and Saskatchewan you can sell it on. This reassignment allows the purchaser to receive the death benefits.
The thing is now you are subject to taxation because you are benefitting in your lifetime from proceeds connected to the policy. Similarly to the client above how much you pay depends on the cash value and how much you receive from the purchaser.
Collateral Loan & Line Of Credit
As I write this, you can use your cash accumulation to secure a line of credit without incurring tax liability. That said, there are risks involved that may subject you to taxation at a later date such as fluctuations of the cash accumulation, changes in interest rates and tax rules.
If you are using your policy as a tool in this way I highly suggest keeping an eye on all the above risks which could change your circumstances.
Policy Withdrawal
Some insurers allow you to withdraw money from the cash that has accumulated in your policy. Any amount that exceeds the adjusted cost basis is considered to be taxable income.
Forgetting to Add a Beneficiary
Many bad things happen when you forget to add a beneficiary. First of all your estate will be designated by the court as your beneficiary. It’s not likely the decision you would have made and to top it off this opens up your life insurance proceeds to taxation.
Ouch.
Is Cash Value of Life Insurance Taxable in Canada?
Another Reason to Call Policy Architects TODAY!
Is cash value of life insurance taxable in Canada? The broad answer to this question is NO! It’s one of the perks of purchasing a life insurance policy. You pay into it until the day you die and your beneficiary inherits the cash and the death benefit – it’s pretty straightforward.
However there are some cool things you can do with permanent insurance like borrowing against the cash value, surrendering the policy if you need the funds or even selling it if you live in specific provinces.
If you use your permanent coverage creatively then you MUST be aware of the potential tax implications. Unfortunately a lot of people aren’t and it comes back to bite them later on.
This is why it’s very important to speak to an independent life insurance agent if you are looking to surrender or borrow against your policy. We can help you avoid the pitfalls.
4 comments
[…] insurance you want (permanent or term) which is dictated by your budget and whether or not you want coverage until the day you die or just periods of […]
[…] If you want coverage until the day you die you need permanent life insurance – which I will not be dealing with here. This is because term insurance works for MOST people MOST of the time. Permanent insurance is much more expensive and needs a lot more direction so I will save that for a different post. […]
[…] kid-focused life insurance products are out there and you can choose from term or permanent plans. A term plan has an end date–often your child’s 18th birthday–while a permanent plan can last […]
[…] Universal Life (UL) is a form of permanent life insurance that covers you until the day you die. Because it has both an insurance and an investment component, It is known as cash value life insurance. […]
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