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Life insurance premiums—the monthly or yearly fees for your policy—are intended to be affordable. After all, you buy it to protect your loved ones’ financial future.
But what if you can take that security further by finding more ways to save, like deducting those premiums from your taxes? Wouldn’t that make life insurance that much more attractive?
But not all premiums are deductible. In this post, we explore situations where CRA will allow you to write off the cost of life insurance from your income tax.
Can You Write Off Life Insurance Premiums On Your Taxes?
The cost for a 20-year term policy for a $100,000 tax-free death benefit can range from $15 to over $200 per month, depending on a wide range of factors. Still, no matter how much or how little you pay, it’s understandable why you would want to save on these expenses.
However, the Income Tax Act (ITA) makes it difficult for individuals and businesses to write off life insurance expenses from their taxes. That doesn’t mean you can’t qualify for some savings—you’ll just have to work with a tax expert to find exceptions to the rule.
But before you go ahead and frantically call a tax professional, you should know what to expect based on your situation.
Unfortunately, the Income Tax Act and similar regulations don’t allow individuals to claim a deduction on life insurance premiums from their taxes—with an exception. That’s because the government classifies life insurance policies as personal expenses.
Qualification Criteria
Despite it being classified as a personal expense, you can qualify for a tax deduction through a process known as a collateral assignment. This is when lenders use the proceeds of your life insurance policy to repay an outstanding loan.
According to paragraph 20(1)(e.2) of the Income Tax Act, deductions from specific income, such as income from a business or property, are allowed if:
- A “restricted financial institution” acquired an interest in a life insurance policy in the context of a loan transaction;
- The financial institution required the borrower to assign the policy as collateral for a loan; and
- The borrower may otherwise deduct the loan’s interest from taxable income.
Let’s break these points down in detail.
The first condition means that you must borrow from a bank, trust company, insurance company, or a similar financial institution for the cost to be deducted. It can’t be a private loan from your family or friends.
For the second condition, the lender must acquire an interest in the policy via a collateral assignment in the loan agreement. For purposes of tax deductibility, you can’t voluntarily assign the policy to the lender. A collateral assignment means that upon your death, the insurance company pays the death benefit to the lender first. Any remaining funds go to your beneficiaries.
For the last condition, you must use the loan proceeds to earn income from a business or property. So, don’t think you can go on vacation with the loan money and still have the premium deducted.
How Much Can You Deduct If You Qualify?
So if you meet those three criteria, how much of your life insurance premiums are tax-deductible?
In paragraph 20(1)(e.2), the Income Tax Act limits how much taxpayers can write off on their taxes. So even if you qualify, your deduction must be the lesser of:
- The insurance premiums paid;
- The net cost of pure insurance (NCPI); and
- The portion of the premium relevant to the outstanding debt.
The net cost of pure insurance is basically the tax cost of the policy. Since permanent life insurance policies have cash value, a portion of the premium goes toward the savings while the rest pays for insurance costs. Because your mortality rate increases as you get older, so too does the NCPI. In fact, in the later stages of the policy, the NCPI might exceed the premium you pay.
Are Charitable Donations Eligible For A Tax Deduction?
Charitable donation by a taxpayer
Suppose you purchase an individual insurance policy and donate it to a charitable organization. In this case, you can claim the receipt for the premium you paid on your taxes.
Rather than a tax deduction, which lowers your income tax by reducing qualifying income, you could qualify for a tax credit, which lowers your tax bill. You can claim a non-refundable tax credit on up to 75% of your net income.
On the other hand, if you name the charity as the beneficiary of your insurance policy. In this case, the organization will receive the death benefit, and your estate will qualify for a tax credit. The limit increases to 100% of your net income in the year of your death and the preceding year.
Charitable donation by your corporation
The tax treatment for a charitable donation through your private corporation is different from that of an individual taxpayer. That’s because instead of a tax credit for premiums paid, your business receives a tax deduction.
For both individuals and corporations, if you can’t use the tax credit or deduction in one year, you can carry it forward for up to five years.
Can You Write Off Life Insurance If You Are Self-Employed?
The booming gig economy and pandemic-induced economic downturn have encouraged many people to turn to self-employment.
While tax-deductible life insurance premiums are available as a business expense, this deduction is generally reserved for business owners who provide group policies for their employees—not self-employed individuals.
Tax Deductions For Businesses
An employer can choose to offer group insurance as part of compensation for employees. For example, you’d often find extended health and dental benefits as part of the package provided by a business.
Another common benefit is group term life insurance. As the name suggests, this offers term life insurance for the employee.
If the corporation pays for group term life insurance costs, it can claim tax deductions on these expenses. It can also claim a deduction on the cost of life insurance for the employee’s family members.
How Much Can Business Owners Deduct?
If you are a business owner, your deduction can cover the entire cost of your employees’ insurance policy premiums if you meet the following criteria:
- You regularly pay the insurance costs,
- The rate does not change according to age or gender.
If you don’t meet these conditions, contact the Canada Revenue Agency (CRA) to learn what deductible percentage of your premium you can claim on your next tax return.
Life insurance policy owned by an employee
If the employer pays for a personally-owned policy by an employee, the employer can deduct premiums against business income. As long as they are a reasonable business expense, CRA won’t have a problem with it.
In turn, the employee must report the benefit on his tax return. For example, suppose you pay your staff $900, plus $100 for their life insurance premium. In this case, you must remit payroll tax and income tax to CRA since your employee technically earned $1,000.
Reporting insurance premiums as a business expense
The CRA states that business owners are required to issue a T4 slip for employees each year. This document includes essential information such as individual annual earnings and benefits received.
It also contains details such as your remitted taxes and a section called code 40 where you can report insurance premiums expenses greater than $25.
Can you claim a deduction on key person insurance?
Key person insurance is when a business insures an employee vital to the success of the company. The corporation owns the policy and is also the beneficiary. Unfortunately, the insurance cost is not a deductible expense for the company.
Because the corporation gets the death benefit, the premium is also not considered taxable income for the key person.
Have Questions About Life Insurance Taxation?
Finding out the tax deductibility of insurance premiums can be a time-consuming and challenging process. In general, life insurance taxation is a complicated topic. For this reason, it’s always best to talk to a tax professional before you do anything.
If you’re in Canada and considering getting life insurance for yourself or a loved one, contact us and get your free quote.
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