Having a life insurance policy has almost become a necessity for Canadian families. It is now common practice for most Canadian companies to offer group life insurance as a benefits package to all their employees. As a result, nearly 80% of all Canadians have some form of life insurance, which for the most part, offers peace of mind above all else.
By paying a nominal monthly or annual premium, a life insurance policy protects your loved ones, from a financial standpoint, in case something were to happen to you. Depending on your policy, the death benefit paid out to your chosen beneficiaries or estate can amount to a substantial sum and can be used to pay off outstanding debts, funeral costs, college fees, and everyday expenses.
However, you likely know this, and what you really want to know is whether your life insurance proceeds would be subject to income tax. To get the answer and all that you need to know about life insurance and its tax implications you have come to the right place!
Are Life Insurance Proceeds Taxable In Canada?
In a word, no! However, there are exceptions. For the most part, an individual’s death benefits or life insurance proceeds are not subject to any form of income tax.
The beneficiaries receiving the proceeds don’t have to report it as taxable income to the CRA when filing their Canadian tax return either. This is also the case for most types of inheritances and financial gifts in Canada. They are all tax-exempt.
There is also no such thing as estate inheritance tax or death tax in Canada. Any death benefits or inheritance received, regardless of amount, isn’t subject to income tax and the beneficiaries or heirs aren’t liable to pay any taxes to the government.
This is why many wealthy Canadian families take advantage of estate planning as it offers more control over how death benefits and inheritance are to be passed down to beneficiaries without having any negative tax implications.
In What Instances Can A Life Insurance Payout Be Taxable?
There are certain instances when a life insurance payout may be taxable.
- Life insurance proceeds can be subject to tax if your estate is the beneficiary of your policy. As estates are considered as an entity and not a person, they are subject to different types of taxes and regulations. This is where things can get a bit complicated as the estate would first have to pay off any probate fees, administration taxes, estate settlement costs, and any outstanding taxes and debts before any of the proceeds can be paid out to the beneficiaries under the deceased’s will. This is why it is always advisable to appoint a beneficiary to your life insurance policy that can then be tied to your estate. Naming a beneficiary on your life insurance policy can also help speed up the settlement process amongst other benefits.
- The type of life insurance policy you have can also determine whether the payouts are taxable. In Canada, there are two forms of life insurance policies; term life insurance and permanent life insurance. Each one of these life insurance policies is then further broken down into several subtypes such as universal life insurance and term-to-100 insurance. This is why it is essential to understand what type of life insurance policy you have to fully grasp its tax implications.
- Certain permanent life insurance policies also come with an investable element that allows policyholders the opportunity to accumulate cash value for further long-term gains. This investment portion is separate from the death benefits that your beneficiaries are liable to receive when you die. As a result, any income or interest generated from the portion of premium payments that were being invested, are subject to income tax.
- If you choose to surrender your policy and receive whatever its cash value is at the time, you will only pay taxes on any amount over what you paid. So, for example, if you paid in $100,000 and when you cashed out you received $120,000. The additional $20,000 will be subject to tax. This is because the gain in value is considered as interest earnings and as such would be taxable as income.
These are some of the most common instances where life insurance proceeds can be taxable in Canada. It is recommended to always consult with a health insurance expert or financial advisor to better understand your life insurance policy and its associated tax implications.
What Are The Canadian Tax Laws Governing Life Insurance Payouts?
The Canada Revenue Agency (CRA) has a simple process when it comes to tax reporting life insurance proceeds. Essentially, if your life insurance policy doesn’t comprise any interest earnings your beneficiaries don’t have to report anything to the CRA. This is why life insurance policies are often the least complicated component of a financial plan.
In the case of a permanent life insurance policy that does contain interest earnings, the insurance provider will send the beneficiary a T5 tax slip. The total interest earned by the policy is reported on line 121 of the beneficiary’s return. This interest amount is treated as investable income and will have to be reported as taxable income. However, any associated death benefits won’t require any reporting.
Making Life Insurance More Efficient For Beneficiaries – McIver Insurance
The entire point of having a life insurance policy is to make life easier for your beneficiaries rather than making things more complicated.
At McIver Insurance we specialize in tailoring life insurance policies that are designed to make things easier and more efficient for both the policyholder and their beneficiaries. Our team works diligently to find you the right policy for your needs at the lowest premiums and advises you on matters of estate and succession planning.
Those of you who still have doubts about your life insurance policy and the amount of coverage you need, or are unsure if a portion of your life insurance proceeds would be considered taxable or not, consult with McIver Insurance – Nova Scotia’s most trusted life insurance broker.
Give us a call at 1-902-220-3279 to learn more!