Table of contents
You know that becoming an informed consumer is key to any significant purchase—especially one as important as life insurance.
But even if you’ve done your homework, you may have many unanswered questions about the taxation of life insurance:
- Do you have to pay taxes on your life insurance proceeds in Canada?
- If so, when would your family receive the death benefit?
- Is this money subject to other taxes?
- What happens if you don’t have a beneficiary?
The list of questions goes on and on. But by learning as much as possible about life insurance—either on your own or with advice from a professional—you can do more to protect your loved ones by making sure they receive the most money in the easiest way possible.
- Key takeaways:
- While insurance proceeds aren't taxable for your beneficiaries, you want to be mindful of who you name as the beneficiary.
- Depending on who gets the money, CRA and other creditors can use the payout to satisfy your debts.
- Unlike the death benefit, taxation of the cash surrender value of a permanent life insurance policy is more uncertain.
The Value Of Life Insurance
When you buy a policy for your family, you’re essentially purchasing peace of mind. Then, when you die, either your beneficiaries or your estate will receive a lump sum death benefit from the life insurance company.
This payment can go a long way to support your family during an emotionally and financially complicated situation by allowing them to:
- Repay outstanding debts, like a home or auto loan
- Meet day-to-day expenses
- Replace or supplement existing income
- Cover funeral costs
Is Your Life Insurance Benefit Taxable?
In short: No.
There are two main types of insurance policies: term and permanent. Under both types of insurance, the death benefit is generally tax-free. This means your beneficiaries do not have to report it as taxable income.
While a term policy only lasts for a certain number of years, you can hold a permanent policy for your entire life. This type of policy does more than other insurance because it also doubles as an investment vehicle. With a permanent policy, you can accrue earnings within your policy completely tax-free. In many cases, policyholders select permanent insurance to assist with funeral expenses after death.
Regardless of your life insurance policy, your beneficiaries don’t have to report the death benefit as income to the Canada Revenue Agency (CRA). It doesn’t matter if you name your spouse, children, parents, estate, or another party as the beneficiary of the life insurance proceeds. Every party will receive the payout tax-free. That’s because CRA doesn’t require them to claim inheritances or financial gifts as taxable income.
Do you pay taxes on your life insurance death benefit without a beneficiary?
No, the death benefit from your life insurance policy is not subject to taxes if you don’t appoint a beneficiary.
However, without any beneficiaries, the insurance company will automatically name your estate as the sole beneficiary. This may be detrimental to your family’s best interests.
Although the government doesn’t directly tax the benefits from your life insurance policy, it can use this money to cover any unpaid income tax from your estate. This includes investment earnings such as capital gains. Besides tax, your creditors can also use the death benefit to pay off your debts. Your family would not receive any funds until these outstanding debts are satisfied.
Intestate succession
In Canada, your death is considered intestate if you die without an official will. This can trigger an expensive probate process that creates more stress for your loved ones. It may also leave them with less money than you want due to costly probate fees and various expenses to lenders and other financial institutions.
When you die intestate, your estate automatically becomes the beneficiary of your life insurance policy. The insurance proceeds are mixed with other assets in the estate, and the province distributes them regardless of what you wanted. In BC, the surviving spouse receives the initial $300,000, while the rest is divided between your spouse and children. But if you don’t have either, the next beneficiaries will be your parents, then siblings.
Deemed Disposition
When planning your estate and considering life insurance, you’ll find that the Canadian government doesn’t impose estate taxes like the US. Instead, your assets are subject to something called a deemed disposition, where your “investments are deemed to be sold at death.”
Furthermore, any capital gains brought on by this sale are added to a final income tax return submitted when you die. In Canada, half of your capital gains are considered taxable income, so you’ll have to add this amount to your final tax return.
However, you’ll be happy to know that the CRA defers the deemed disposition if your surviving spouse receives your assets through a rollover or trust. Your spouse will only pay taxes if he or she sells the assets.
And when other beneficiaries receive these upon your spouse’s death, half of the capital gains will be taxed on the final income tax return.
Do You Pay Taxes On The Cash Value Of A Whole Life Insurance Policy?
Yes—if you surrender your life insurance policy and the cash value exceeds the adjusted cost base of the policy (ACB).
Permanent life insurance policies can accrue cash value, which you can get by cashing out your policy. When you surrender a permanent policy, you exchange your death benefit for a cash payout from your insurance company.
In this situation, it is taxed as ordinary income—not capital gains—since the government counts the cash value as income.
While premiums are not tax-deductible, a permanent policy is still a valuable place to invest tax-deferred. By accumulating interest, it generates even more wealth for their beneficiaries.
How to report cash surrender value on your tax return
While your investments inside a life insurance policy grow tax-sheltered, you may have to pay tax on the cash value as soon as you cancel the policy.
Your insurance provider will issue a T5 slip to you with the reported policy gain. Here, you can include the amount on line 12100 of your tax return.
A more tax-efficient way to get money out of your policy
Sometimes, you’re strapped for cash and need to turn to your insurance policy. That’s fine. But cashing it out might not be the most tax-efficient way to access the money since it might be subject to tax.
Instead of surrendering your permanent life insurance policy, you can get the cash out via a policy loan. In this case, the loan is only taxable if it exceeds the adjusted cost base of the policy.
You can also use the policy as collateral for a loan. In this case, you get the loan without paying any taxes. However, you need to assign the policy to the lender. This means that if you pass away, the loan is paid off first. After that, any remaining amount goes to your beneficiaries. In a way, a collateral assignment means the lender becomes a beneficiary of your insurance policy.
Get Help With Your Life Insurance Tax Questions
A life insurance policy is one of the best ways to protect your loved ones from the unexpected. However, there are many types of life insurance policies, and picking the right one can be challenging. That’s why you should always talk to a financial professional before the life insurance company.
When you are more informed about life insurance taxes, you get answers to important questions that you can’t answer when your family receives the death benefit. In doing so, you do more to safeguard their financial future while saving them significant stress during a tumultuous time.
Contact us at info@briansoinsurance.com or 604-928-1628 today if you want to get started on a life insurance policy or need advice about insurance in Canada.
Get Your Life Insurance Quote Now
While we make every effort to keep our site updated, please be aware that timely information on this page, such as quote estimates, or pertinent details about companies, may only be accurate as of its last edit day. Brian So Insurance and its representatives do not give legal or tax advice. Please consult your own legal or tax adviser. This post is a brief summary for indicative purposes only. It does not include all terms, conditions, limitations, exclusions, and other provisions of the policies described, some of which may be material to the policy selection. Please refer to the actual policy documents for complete details which can be provided upon request. In case of any discrepancy, the language in the actual policy documents will prevail. A.M. Best financial strength ratings displayed are not a warranty of a company’s financial strength and ability to meet its obligations to policyholders.
Can I use my permanent life insurance as collareal for a loan from my benefiary
I carried a life insurance policy for my child who is now an adult,I am still paying the premiums, can I gift her the cash surrender valve as a gift ?
Hi Ambie. You could withdraw the cash value and gift it to her. However, there might be tax payable on the withdrawal. There’s also the option of a policy loan, which will have interest charged and may also have tax consequences.
Another option, I think Ambie can have the life insurance company transfer the policy to her child and the cash surrender value used to continue payments within the policy.