Is Life Insurance Taxable In Canada?

March 7, 2022
Whether you’ve just bought a life insurance policy or are interested in getting one, it’s natural to have questions. And one of those might be – what the tax implications are of your life insurance policy. In other words, is life insurance taxable in Canada?

What Is A Life Insurance Policy?

Let’s start with the basics. A life insurance policy is a form of protection that you buy for your family. If you pass away, your loved ones will be paid a death benefit from the life insurance company. This helps them meet financial obligations if something happens to you. Life insurance offers peace of mind for your family.

There are two types of life insurance that you can buy from a life insurance company:

Term Life Insurance

Term life insurance policies are one type of life insurance that is in place for a specific term. For example, you can buy life insurance for 10 or 20 years. Sometimes a life insurance company will even allow you to buy coverage until a certain age, such as 65.

Permanent Life Insurance Policy

Permanent life insurance is also known as whole life insurance. This insurance policy will be valid for your entire life. What type of insurance you select is completely up to you. However, you may need to undergo a medical exam for some life insurance policies.

With this background, let’s consider whether your life insurance policy is taxable in Canada.

Is Life Insurance Taxable In Canada?

When people ask whether life insurance is tax-free or not, they’re usually referring to the life insurance proceeds or death benefit paid to beneficiaries. In most cases, the death benefit is tax-free or non-taxable. This applies to both term and permanent life insurance or whole life insurance. That means, your beneficiary won’t need to report life insurance proceeds when they pay tax.
Come tax season, are you wondering if your new life insurance policy is taxable in Canada?

Purpose of Life Insurance

Life insurance proceeds or the death benefit replaces the lost income that beneficiaries experience when you pass away. The goal is to help your loved ones continue to make ends meet during a tough time. That means your family will be able to use the money to pay down debt, make mortgage payments, or even cover the funeral costs.

There is no limit to how beneficiaries can use the death benefit. And they won’t need to report the money they receive from your life insurance policy when they file income tax. The Canada Revenue Agency does not require anyone to pay taxes on inheritances or most financial gifts.

Are Life Insurance Premiums Tax-Deductible?

Another question that life insurance policyholders have is whether or not they can claim any premium paid as a tax deduction on their Canadian tax return. In Canada, the premiums you pay for life insurance are not tax-deductible. However, if you are a business owner and have life insurance coverage for employees, you may be able to claim premiums as a business expense on your taxes.

Do You Pay Taxes On The Cash Value of A Life Insurance Policy?

Permanent life insurance or whole life insurance offers the added benefit of accumulating cash value. Cash value is money that is part of the life insurance premium you pay and is usually invested so it can grow. It’s important to note that cash value is only accumulated with permanent life insurance policies, not term life insurance.

Some permanent life insurance policyholders decide to cancel their life insurance, and if there has been cash value accrued on the policy, they’ll get that money. In this scenario, the funds would be considered income, and you’d have to include it on your income tax return and pay taxes on it. You’ll need a T5 slip from the insurance company for your income tax, and you’ll report the cash value on line 12100 of your tax return.

When Is A Death Benefit Taxable In Canada?

Although you won’t have to pay taxes with life insurance, there are a few instances where the death benefit may be taxed. These include:

Loan Collateral

Sometimes people will offer their life insurance as loan collateral to a loan provider. In other words, after you pass away, the death benefit will be used to pay off any outstanding loan balance. However, if that doesn’t cover the balance of the loan, your beneficiary will need to pay taxes on the remaining amount.

No Appointed Beneficiary

The death benefit will transfer to your estate if you pass away without naming a beneficiary for your life insurance policy. This is done automatically for any life insurance that doesn’t have a beneficiary appointed. If you have unpaid taxes, the government can tax your estate, which means the death benefit will be considered taxable income. Moreover, any money from your estate can also be used to pay off outstanding debts owed. That means your family won’t receive any cash until all your liabilities have been cleared.

Intestate

When someone in Canada dies without a will, the death is considered intestate. If you have a life insurance policy and you die intestate, the death benefit will go to your estate. The outcome is similar to not appointing a beneficiary for your life insurance. The money will become part of your estate and may be used to pay taxes you owe that are determined by your final tax return or other debt.
If you received a life insurance payout as a primary beneficiary, your money is not taxable.

Selling Your Policy

Not all provinces allow you to sell your policy, but if you live in one that does, the income you make from the sale will be taxable. How much you’ll pay in taxes depends on several factors, including the type of policy, how much you have paid to the insurance company, what your insurance policy sold for, and if there was cash value.

Why Work With Shelter Bay Financial?

At Shelter Bay, we know insurance. And we also know you may have questions about life insurance and your coverage. With Shelter Bay Insurance, you can rest assured we’ll give you the straight answers to your questions. That’s because, unlike other insurance companies, we don’t work for just one insurance provider. Our brokers have access to several different life insurance policies. We’ll be able to find the right amount of coverage for you.

Whether you’re ready to buy life insurance or just have some questions about life insurance, contact Shelter Bay today.

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