Life insurance is a crucial financial tool that will provide financial protection and peace of mind to the loved ones of the policyholder. However, many people often have plenty of questions about life insurance, including is life insurance taxable in Canada?
Knowing this answer is crucial to your financial planning and dealing with the estate after death. Thankfully, we’re here to help. We’ll look at if life insurance is taxable in Canada while also answering any other relevant questions you may have.
Is Life Insurance Taxable in Canada?
The simple answer is no: life insurance is not taxable. You can use the death benefit in any way you want without including it as income on your tax returns. This is true whether you are using the money to pay off a mortgage, as an income replacement, or for any other reason.
Whether the life insurance policy is term, whole life, or universal life, the tax-free status of the death benefit remains consistent. This is one of the significant benefits of life insurance, as the death benefit stated in your policy is what you’ll receive without any deductions.
We said the simple answer is no, as there are rare times when life insurance can be taxable, and we’ll look at those here. However, for a simple policy where the beneficiaries named on the policy have received the death benefit, it is not taxable.
Investments within Life Insurance Can Be Taxable
While the death benefit itself is usually tax-free, investment components within permanent life insurance may not be. These types of life insurance policies usually have cash value components that grow over time and can be invested. Any earnings generated during the policy will be subject to tax, but not while they remain in the policy.
How this is taxed will depend on how it is managed. This is why it’s important to work closely with your insurance or financial advisors to understand the exact tax implications. This will allow you to make informed decisions based on your financial goals and circumstances.
Taxation of Your Surrender Value
That cash value component of permanent life insurance can also be surrendered (withdrawn) before death for those wanting to have access to the money. This surrender value is the cash value of the policy minus any applicable surrender charges.
When surrendered, any gains within the cash value will most likely be subject to taxation on your earnings. Additionally, if you die and your beneficiaries receive money from dividends and interest, then that will also be taxable.
Tax on Your Estate
When setting up a life insurance policy, you need to select who will be the beneficiary, such as a spouse or children. However, you can also choose the benefit to be paid into your estate, or this will naturally happen if your chosen beneficiaries have passed away.
If this happens, then the life insurance will become a part of the estate along with all other assets. Whether or not tax will be due can depend on the overall value of the estate. This estate will be then divided in accordance with the will or will follow intestate succession rules.
It’s for these reasons that it’s vitally important to properly name the beneficiaries of a life insurance policy and keep them updated. Otherwise, you run the risk of the death benefit being paid into the estate and potentially becoming taxable.
Tax Treatment of Life Insurance Premiums
Another question people commonly have is whether the premiums paid for life insurance are tax-deductible. The bad news is that in Canada, any premiums you pay are generally not tax-deductible.
This means that individuals cannot claim a deduction on their income tax return for any premiums they pay. This is the same for all types of life insurance, as premiums are considered a personal expense.
There are very rare exceptions, such as if you’ve used your policy as loan collateral or have borrowed against the cash value of your policy. You may also receive a tax credit if the policy is charity-owned. However, these depend on specific circumstances, and it would be best to speak to a tax professional to see if you are eligible.
Final Thoughts
Understanding the tax implications of life insurance in Canada is vital. For the vast majority of beneficiaries, the cash payout is not going to be taxable. You can rest easy knowing that this won’t form a part of your income tax return, and you can have peace of mind.
However, as we’ve seen, there are exceptions where a tax amount may be liable depending on a wider range of factors. This is generally if there is an investment component in the policy, it has been surrendered, or if it has been paid into the estate.
If you think a life insurance policy may fall under one of these exemptions, then it’s important to get professional advice. If you’re interested in a life insurance policy or simply have any further questions, then contact Buckler Insurance today, and we’ll be more than happy to help.
