What are The Tax Implications of a Family Life Insurance Policy?

Buying a life insurance policy is much like buying a home or a car for the first time. It requires careful deliberation and consultation with experts to help you make a more informed decision.

If you are considering investing in a life insurance policy you may feel that the more you dig the more you learn and the more you uncover. While many people consider life insurance to be a tool to help safeguard your loved ones from financial distress there is a lot more to life insurance than just that. 

Take tax, for example. Depending on your life insurance policy you could be faced with different types of tax implications for both you and your loved ones. 

As such, you may be wondering, do you have to pay tax on your insurance proceeds, or will your beneficiaries be liable to pay tax upon receiving the allotted death benefit? 

These are all valid questions and we are here to answer all of your tax-related queries. So, let’s get to it!

What Is A Family Life Insurance Policy?

A family life insurance policy is essentially a comprehensive insurance coverage plan that includes permanent life insurance, term life insurance, critical illness insurance, disability insurance, and children’s term insurance. 

This form of insurance plan offers comprehensive coverage for the policyholder and their family members, ensuring the family’s continued financial stability even after the policyholder passes away or is unable to earn an income. 

The beneficiaries can use the insurance payouts of a family life insurance policy to pay off any outstanding debts, cover funeral costs, meet monthly expenses, pay for children’s schooling, and much more. 

Is A Family Life Insurance Policy Taxable?

The payout received from a life insurance policy in Canada isn’t subject to any income tax in most cases, whether that be the premiums you pay or the benefits or payouts that you or your beneficiaries receive. It is all tax-exempt!

In fact, according to Canadian tax law, most types of inheritances and gifts aren’t taxable regardless of how expensive or valuable the gift or inheritance is.

As such, beneficiaries receiving a death benefit don’t have to report it when filing their Canada tax return, no matter the size of the amount they receive, as is the case for gifts and inheritance. 

No estate inheritance tax has to be paid by beneficiaries or heirs as any liable tax is paid by the estate itself. 

However, in certain situations, a life insurance payout can be taxable. Here is how.

Instances When A Life Insurance Payout Is Taxable

A family life insurance policy is often made up of a combination of policies including term and permanent life insurance. 

Permanent life insurance policies differ from term life policies as they have no definitive term and can be held for life. However, that isn’t the only difference. 

These policies also offer policyholders the opportunity to accumulate cash value on the premiums they pay. In such a case, a portion of the premium amount is saved in the policyholder’s cash value account where the money is invested to earn interest and grow. 

While the gains you make aren’t taxable, similar to an RRSP or TFSA, if you choose to surrender the policy and receive its cash value or withdraw the money in your cash-value account, you will have to pay taxes on any gains that your investments have made. 

To calculate this you simply have to total what you have paid so far in premiums against what you have received. The difference is the amount you will have to pay tax on. 

This is also the case for your beneficiaries. While the death benefit they receive isn’t taxable, any gains or interest earnings from the policy will be taxable as income and must be reported to the CRA when filing a tax return.  

If you are a beneficiary of a permanent life insurance policy and aren’t sure whether you have to pay tax or not, just remember this simple rule:

 If the payout you receive has come with a T5 slip from your insurance provider, you will have to report those earnings on line 121 of your tax return. 

If you don’t get a T5 slip and just a lump sum amount after filing an insurance claim, you don’t have to report any of that money to the CRA.

Frequently Asked Questions

Q) Are life insurance premiums tax deductible?

Life insurance premiums aren’t subject to any income tax, sales tax, or estate tax, and as such they are not tax deductible. However, if you are a business owner and you consider the premiums you pay for your employees as a business expense, then premiums can be considered tax-deductible.

Q) What are the tax implications of borrowing against a policy?

Borrowing money against your life insurance policy is generally tax-free. However, if your policy lapses or you don’t repay your loan the amount borrowed will then be subject to tax just like any ordinary loan. 

Q) Do you have to pay taxes when transferring a life insurance policy?

In most cases, you don’t have to pay any tax when transferring ownership of a life insurance policy. However, you do have to be careful about transferring ownership of a life insurance policy as it can have estate tax implications. Always consult with an Insurance Advisor before considering a transfer of ownership.

Consult With A Life Insurance Advisor To Learn More!

The type of life insurance plan you choose can have significant tax implications for you and your loved ones. As such, it is always best to consult with the experts before opting for a coverage plan.

The type of coverage plan you need may be quite different from someone else and an expert can help you find that right balance between coverage and cost. 

At McIver Insurance, our Halifax Life Insurance Advisors have years of experience and extensive knowledge of the tax implications that a family life insurance policy can have on a policyholder and beneficiaries. 

For more information and guidance give us a call at 1-902-220-3279 or email [email protected]