Table of contents
Is the lump sum benefit you receive from critical illness insurance taxable? Whether you have a personal policy or your employer pays for your coverage, you’ll want to know if you have to pay tax on the benefits.
That’s because when it’s time to make a claim, the last thing you want to worry about is whether taxes will affect the benefit amount.
In this post, we’ll reveal the tax implications of a critical illness insurance payout. So, let’s dive in and explore this important topic in detail.
What Is Critical Illness Insurance?
Critical illness insurance provides financial assistance if you are diagnosed with a life-altering illness by paying a lump sum benefit. You can use the payment however you want, including paying for personal living expenses while you recover from the disease.
In many cases, getting a severe illness like cancer or a heart attack can bring additional costs like travelling out of town for treatment or modifying your home to improve accessibility. The lump sum payment can help cover these expenses, so you can focus on recovery without worrying about the financial consequences of a critical illness.
How much critical illness insurance should you get?
How large of a critical illness insurance policy you should get is up to you. Ideally, you’ll want the payout to cover the expenses mentioned above so you don’t have to dip into your retirement funds.
Typical amounts are one to two times your annual income or multiples of $50,000, like $100,000 or $200,000. Of course, the higher the critical illness insurance payout, the higher the premium payments.
Is the critical illness insurance payout a lump sum cash payment?
Yes. Unlike disability insurance, which pays a monthly benefit for as long as you’re disabled, critical illness insurance provides a lump sum cash payment. This makes it similar to a life insurance policy, which also pays a single death benefit. The difference is the beneficiary, which would be your loved ones for life insurance and you for critical illness insurance.
Is critical illness insurance worth it?
Given the financial safety net a critical illness insurance policy provides, it would be wise to invest in one. However, you have to factor in the cost when weighing the pros and cons.
For insurance, the cost is the premiums paid for the policy. As insurance premiums become more expensive the older you are, critical illness insurance may be more worthwhile for younger individuals than someone in their 50s or 60s.
Is The Payout For Critical Illness Insurance Taxable?
In short, no. However, you should be aware of the tax consequences of different scenarios, like the return of premium, a group critical illness insurance plan, and corporate-owned policies. So let’s take a look at each one in detail.
What are the tax implications of a personal critical illness insurance payout?
Because you pay the premium payments with after-tax dollars, you will receive the lump sum payment tax-free. For example, say you bought a critical illness insurance policy with a benefit amount of $100,000. Upon the diagnosis of a covered condition, the insurance company will cut you a cheque for $100,000. You won’t receive a corresponding tax slip to report the benefit on your tax return.
Is the return of premium benefit taxable?
Return of premium is an optional rider you can add to your critical illness insurance policy. If you don’t make a claim, it lets you get back the premiums paid into the policy. For example, if you paid $10,000 into the policy over many years and never made a claim, you will receive $10,000 as a return of premium.
The three most common return of premium riders are:
Return of premium on death: Pays the critical illness insurance premiums to your estate or beneficiary if you die while the coverage is in force.
Return of premium on expiry: Returns the total premium paid to you when you cancel the policy.
Return of premium on surrender: Returns the total premium paid upon the expiration of the policy, usually at age 75.
In either case, your benefit will be received tax-free by you or your estate. This means your estate wouldn’t have to pay tax on the payout for the return of premium on death.
However, the money would have to go through probate before it’s distributed to your beneficiaries, adding to the cost. The probate fee depends on your province of residence and is the highest in BC, Ontario, and Nova Scotia.
To avoid the cost of probate, you may want to consider naming a beneficiary to receive the return of premium upon your death.
Are critical illness insurance benefits from a group insurance plan taxable?
Companies often provide employment benefits to their employees as part of their compensation. These plans usually include life insurance, disability insurance, and extended health insurance.
As employees’ demands rise, so too do employers’ offerings. As a result, more companies now provide critical illness insurance in their group insurance packages.
When an employer pays for critical illness insurance, the premiums paid are a deductible expense for the employer. In turn, the premium payments become a taxable employment benefit for employees. Since it is considered taxable income, you have to report it on your tax return.
If you are diagnosed with a covered illness, you will receive the benefit tax-free.
Can you claim the medical expense tax credit for the lump sum payment?
While the lump sum payment doesn’t qualify for the medical expense tax credit, you can use the proceeds to fund medical expenses. You can claim the medical expense tax credit if they are eligible expenses under the Income Tax Act. For example, you can use the benefit to pay for prescription drugs and claim the tax credit.
Can your corporation receive the benefit tax-free?
Besides owning a critical illness insurance policy personally, you can also hold it within your private corporation. The payout can help keep your business running by paying salaries, utilities, and rent. It can also cover the cost of hiring a temporary replacement so your business continues uninterrupted.
Because you don’t incur critical illness insurance premiums to earn an income, they are not tax-deductible. However, the benefit from an accident and sickness policy is tax-free, even if your corporation receives it.
Unlike the proceeds of a life insurance policy, which can give your corporation a capital dividend account credit, there is no such mechanism with the critical illness insurance benefit. As such, life insurance policies may provide more opportunities for tax planning.
How does the tax treatment of critical illness insurance affect the amount you need?
Depending on your tax bracket, the fact that critical illness insurance is non-taxable may substantially impact the amount of coverage to get.
If you were in the highest tax bracket, a taxable benefit would have cut your net proceeds in half. Therefore, you might have planned to get double the amount of coverage to account for the tax hit. Knowing the benefit is not considered taxable income means you can save half the premiums paid by opting for a smaller policy.
Get Help With Your Critical Illness Insurance Tax Questions
Critical illness insurance can be a valuable safety net, but it’s essential to understand how taxes can impact the benefits you receive. If you’re considering this type of coverage, we recommend speaking with a licensed insurance advisor to ensure you have the right policy for your needs. Don’t wait until it’s too late—protect yourself and your loved ones by considering critical illness insurance today.
And remember, consult with a tax professional to determine the tax implications of any benefits you receive.
Contact us at info@briansoinsurance.com or 604-928-1628 for a free no obligation quote. We’ll gladly help you find the right coverage that fits your needs and budget.
Get Your Critical Illness 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.
