Is Life Insurance Taxable in Canada?
The benefits of life insurance are obvious, but there are many rules, terms, and regulations around its policies. This uncertainty leads many people to ask is life insurance is taxable in Canada?
With tax needing to be paid on a wide variety of financial products, it’s a sensible question to ask. Here we’ll clear up this question, while also looking at whether or not your premiums are tax deductible. Read on for everything you need to know about tax and life insurance policies.
Is Life Insurance Taxable in Canada?
What people mainly want to know when asking this question is: Do the beneficiaries have to pay tax on the lump sum they receive from a life insurance policy? The answer to this question is no. This amount will be received tax-free and those who receive it don’t need to worry about declaring it.
The only exemption with the lump sum is if no beneficiary is declared in the policy. If this is the case, the cash lump sum will be absorbed into the estate. This can then be subject to any tax paid on the estate. However, if any beneficiary is named, this is something you don’t need to worry about.
This is one of the most significant advantages of life insurance in Canada and makes it an effective tool for estate planning. However, there are other parts of permanent life insurance that can be taxable, which we’ll explain fully below.
Related Article: https://www.rjins.com/resources/our-blog/how-does-life-insurance-work-in-canada/
Is Your Life Insurance Tax Deductible?
Before we get on to potential tax implications, let’s clear up another common question. The premiums you pay for personal life insurance are not tax-deductible. Simply put, you cannot reduce your taxable income by the amount you spend on your premiums. This is true for any type of personal policy.
When Can Life Insurance Be Taxable?
It’s important to note that life insurance can be much more than just a lump sum. Before we get into that, let’s briefly explain the two main types of life insurance.
Term Life Insurance – As the name suggests, term life insurance covers you for a specific term, such as 10 years. Once those 10 years pass, your policy expires. If there is a death withing that term, the amount received is completely tax-free and you don’t need to worry about any financial implications.
Permanent Life Insurance – Along with the non-taxable lump sum, permanent life insurance can include other elements such as a savings or investment component. What you do with this cash value can have tax implications.
Taxation of Cash Value in Permanent Life Insurance
Permanent life insurance policies can accumulate a cash value over time. This can be accessed by the policyholder in a few different ways including withdrawals, policy loans, or surrendering the policy. The tax implications of these transactions can vary.
Withdrawals – The amount withdrawn is usually subject to tax. This will be the amount you receive after any fees or commissions.
Policy Loans – Any amount borrowed against the cash value is not taxable. However, if the policy lapses or is surrendered, it may become taxable.
Policy Surrenders – If the policyholder surrenders the policy, the cash value received will be taxable, minus any costs.
Taxation of Dividends from Participating Life Insurance
Participating life insurance is a type of whole life insurance where dividends may be paid to policyholders. This dividend can be used in several ways but if it’s withdrawn in cash, it is taxable. If the dividend is reinvested into the policy, it isn’t taxable.
Other Instances Where Life Insurance Can Be Taxable
There are a couple of other times when life insurance can be taxable, but these are rare:
Selling Your Policy – If you sell your policy, then this will be taxable. This is generally only done if the policyholder is desperate for cash, as they’ll receive significantly less than their death benefit. However, this is only legal in a few provinces.
Interest – If the beneficiaries receive interest from the policy, this is usually taxable. However, it’s important to state that any increase in value while the policy is still active won’t be taxable.
Estate Planning and Life Insurance
The bottom line is the lump sum received from a life insurance policy will not be taxable, as long as there are beneficiaries to receive it. This can provide them with financial security to cover expenses and give long-term security.
The tax-free nature of this can be vital for preserving the value of the estate and avoiding the sale of any assets. If you’re considering life insurance, it’s an excellent way to ensure the people you love can financially cope after loss, usually with no tax considerations.
Final Thoughts
For the vast majority of Canadians, the life insurance payouts that beneficiaries receive will be completely non-taxable. As we’ve seen above, there are only a few instances where this isn’t true and these will only apply in non-standard cases.
Understanding this can be crucial for effective estate planning. If you’re interested in life insurance, it’s important to get a policy that is perfectly suited to your needs. Contact Ron Johnston Insurance today and we’ll be more than happy to assist in finding the right policy for you.