Is Life Insurance Taxable in Canada? Words of Wisdom From An Agent!
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.
….but that’s not the end of the story. The question “is life insurance taxable in Canada?” is a little more involved than that.
There are considerations when it comes to life insurance and taxation. I’m briefly reviewing a few key points now and will publish a more in-depth guide in the near future.
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.
This is not possible if the CRA takes a chunk.
That being said, taxes are a very big consideration when you die. When you pass away, you still have tax obligations to fulfill.
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 the obligations.
Life insurance money can be used to do this, so an inheritance won’t cause any financial duress.
When Life Gets Real
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.
Is Life Insurance Taxable In Canada:
Is Leaving Your Policy To Your Estate a Good Idea?
The problem with this approach 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.
Maintaining some element of control over the funds may be terribly important for various reasons. If this is the case you can leave the policy to the estate. It’s a little more complicated as your chosen representative has to file the final tax return, but the good news is you retain control.
After the taxes are settled, the remainder of your estate passes 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.
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.
In terms of tax consequences, it’s a no brainer. The funds are not taxable…
…..term coverage can be also 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 Canadian 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) costs 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 are triggered, and
2) the cash value account remains intact and continues to grow tax-free. Not to mention, many financial institutions even capitalize the loan. So in effect your not making any interest payments on the loan.
Sounds Too Good To Be True
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 a 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.
Call us at Policy Architects today. We can help you find the right solution!