Is Life Insurance Taxable

Is life insurance taxable in Canada? This is a question I get all the time!

People buy life insurance so that if the unimaginable happens they’ll be financially protected. It’s one of those purchases that no one wants to talk about but everyone needs. That’s why the tax implications are such an important part of life insurance planning. My clients simply want to know where their beneficiaries stand if and when they have to make a claim. 

No one wants their loved ones to be hit with an unexpected tax bill. The good news is your beneficiaries receive their payout TAX-FREE. It’s one of the biggest perks of purchasing a life insurance policy. If the proceeds were taxed it would substantially reduce the amount of money they get. 

….but that’s not the end of the story. The question “is life insurance taxable in Canada?” is a little more involved than that because there are other considerations when it comes to life insurance and taxation. I’m going to briefly review a few key points now and will be publishing a more in-depth guide in the near future. 

Who Am I & Why Do I Care? 

My name is James Heidebrecht and I’m the founder of Policy Architects. Life insurance is my industry of choice. I got into this business a little later in life, but it’s a true passion. Having a son and seeing just how unpredictable life can be has given me insight into how important my coverage is.

Both my wife and I have seen first hand what happens if a breadwinner dies early in life with a young family. The financial repercussions are disastrous. Let’s face it, most of us are just living pay check to pay check, but the bills and debts don’t go away when we die. They are just handed off to our loved ones.

If you’re Googling “Is life insurance taxable in Canada” it means you’re doing your research – kudos to you! …but if you really want some great advice, why not give the professionals at Policy Architects a call today? We have all the information you need and can help you find a way to use life insurance to offset taxes and protect your family. It’s a win-win. 

Is Life Insurance Taxable In Canada & Other Considerations 

So let’s get back to the subject at hand. As I mentioned above, life insurance payouts after death aren’t taxable which enables you to leave your beneficiaries a serious lump sum, which would not be possible if the CRA took their share. That being said, taxes are a very big consideration when you die, which means they play a big role in life insurance planning. 

When you pass away, you still have tax obligations to fulfill. Yep. So if you have a large estate, planning is even more important. If your beneficiary doesn’t have a lot of liquid funds this could cause a serious cash flow issue that may result in some unintended consequences. For example, if you want to leave the family cottage to your kids and they can’t afford the tax bill, they may have to sell the property to satisfy their obligations. Life insurance money can be used to do this, so an inheritance won’t cause any financial duress. 

The couple has decided to leave the cottage to their older son, since his children have also come to love it. The property, which the couple bought years ago for $200,000, is now worth four times that. Let’s assume that the couple’s other child, a younger daughter, doesn’t plan to use the property as she starts her life in New York. She will be given a comparable inheritance, say $800,000.

Now the unhappy truth: Second homes, cottages and other vacation properties are taxable assets. Unlike a primary residence, the increase in value of a second home is taxed, so the son will receive a major tax hit.

Leaving the family cottage to children will cost you – or them, The Globe and Mail 

Is Life Insurance Taxable In Canada: Leaving Your Policy To Your Estate - Is This a Good Idea? 

The thing is you lose control once your beneficiary receives their payout. So if you intend for them to pay off estate taxes immediately you’re out of luck if they decide to do otherwise. If maintaining some element of control over the funds is terribly important, you can leave the policy to the estate. This is a little more complicated as your chosen representative will have to file the final tax return for you.

After the taxes are settled the remainder of your estate will pass on to the beneficiary named in your will. 

This is a great tactic if you don’t happen to have confidence in the financial prowess of your beneficiary. It also frees up your grieving relative to deal with your death instead of tax obligations. There are many ways to manage this sort of situation that includes creating a trust. I will get into this in another article as this is a topic that deserves its own post. 

NOTE* I wouldn’t recommend this course of action unless absolutely necessary. Any time policy proceeds flow to an estate, they DO NOT bypass probate and anyone waiting for money on the other end can expect a delay of 6 months to a year or more!

There Are Two Different Types Of Life Insurance 

Sure we can simplify just about anything – but there’s a lot more to the question “Is life insurance taxable in Canada?” than meets the eye. 

Did you know there are two types of life insurance? Term life insurance is the most familiar. You pick a period of time you want to cover, pay your level monthly premium and your beneficiary receives a predetermined payout if you happen to die during that period of time. In terms of tax consequences, it’s a no brainer. It’s not taxable, but it can be used as a tax planning tool. 

Then there is permanent life insurance. The difference between permanent and term is that you’re covered for life, which guarantees your beneficiary a payout as long as you stay current with your premiums. There is also a cash value component, which means a portion of your premiums is allocated to savings that you can access in an emergency or during your lifetime depending on need. 

The question “is life insurance taxable in Canada?” gets a little more complicated if you’re talking about permanent life insurance 

Beware Permanent Insurance: The Tax Implications of Using Cash Value or Borrowing Against It

The good news is exempt policies defer taxes and almost all Candian permanent policies are exempt.

Ok so let’s say something comes up and you need some cash. Maybe your son or daughter is going to graduate school and you’d like to help them out. You don’t want them to wait until you die to benefit from their inheritance. So, should you: 

A) opt to take some of the cash value of your policy now, or

B) borrow against the accumulated funds in your policy?

The answer is B), take a loan out against the cash value of your policy. 

Why, what’s the difference?

The Devil's In the Details!

If you’re asking yourself is life insurance taxable in Canada,  it can be! Especially when you access the money before you die. Surrendering your permanent policy or taking cash out in excess of the policy’s adjusted cost basis (ACB) will cost you big time. The Canadian Revenue Agency (CRA) considers either of these sources taxable income to you as the policyholder. Therefore, gains are taxed like interest income (100% income inclusion).

On the other hand, because loans aren’t taxable in the eyes of the CRA, using your investment account as collateral for a loan is your best bet. That’s because:

1) No taxes will be triggered, and

2) the cash value account remains intact and continues to grow tax-free. Not to mention, many financial institutions will even capitalize the loan so in effect your not making any interest payments on the loan. 

When you die, the policy loan and any interested are paid off tax-free out of your death benefit. Any money left over goes to your loved ones tax-free. 

It almost sounds too good to be true, doesn’t it?  Well, it can be if you’re not able to swing the premiums on your permanent life insurance policy. And this is a problem for many people. Find out if cash value life insurance is right for you and check out my post here.

Is Life Insurance Taxable In Canada: Beware Of Changes to Tax Exempt Policies 

This is a changing area in life insurance, so keep your eye on this space. Restrictions were placed on the acceptable amount of cash accumulation within exempt policies in 2017. If you have a sizeable estate be sure to speak with an independent life insurance agent for clarification. We can help you go through all the details! 

So the simple answer to the question, “is life insurance taxable in Canada?” is – no it’s not!

Although this is a different story if you access the cash value built up through your permanent policy during your lifetime. Life insurance is an incredible tool and one of its most important uses is for tax planning. This is especially true for those of you that would like to leave property or a business to your loved ones. It’s so important for you to think about the consequences of your death before your family is hit by a hefty tax bill. Losing someone is tough enough, you don’t want to add financial distress to the mix. 

I will be sharing an estate planning guide later this year, as I find this one of the most interesting areas of life insurance. Using trusts and charitable donations to manage your tax obligation just scratches this surface of this incredibly interesting topic.

James Heidebrecht is Life insurance Taxble