Blog Post

Is life insurance taxable in Canada?

For most Canadians, the answer is no. This makes a Canadian life insurance benefit an effective way to leave financial support for your loved ones.

As tax season rolls around, you may be wondering where life insurance fits into the picture. Do you need to report your life insurance policy on your tax return? How will taxes affect your life insurance policy in the future?

Understanding how your policy works when you pass away can help your beneficiaries experience the full benefit of the money you leave behind. Ensure you take the necessary steps to protect your loved ones.

Table of contents

• A closer look at the question, “is life insurance really taxable?”
• When will you need to pay taxes on life insurance?
• Non-exempt and exempt life insurance in Canada
• How your family can benefit from tax-free life insurance
• Is life insurance right for you?

A closer look at the question, “Is life insurance really taxable?”

Are life insurance proceeds taxable? Generally, no. Is a life insurance payout taxed? Again, no. As we mentioned at the top, beneficiaries receive non-taxable benefits. By non-taxable, we mean that your beneficiaries won’t need to pay income tax on the amount they receive when you pass away.

This is often the case regardless of the size of the policy, your partner or anyone else you’ve named as a beneficiary. If you’re choosing between term and permanent life insurance policies, don’t worry, both are generally considered tax-exempt insurance plans.

When life insurance remains non-taxable, you do not need to report the interest gained on your death benefit on your annual tax return.

However, there are certain situations in which taxation applies to life insurance.

When might you need to pay taxes on life insurance and could there be tax savings?

While the answer to “are life insurance benefits taxable in Canada?” is mainly no, there are some exceptions where taxes may apply. Here are five situations to be aware of:

1. No beneficiary

If you do not appoint a beneficiary to your life insurance policy, when you pass away, your estate will automatically be the designated beneficiary. If your estate is the beneficiary, then your death benefit may be subject to estate administration tax. The best way to avoid this tax is by ensuring that you designate a trusted beneficiary.

2. Loan collateral

A reason you may potentially save on taxes is when your life insurance policy is used as collateral for a loan. Depending on how the loan is used, the interest on the loan and a portion of life insurance premiums may be tax deductible. This means that if tax criteria are met, servicing costs of the loan and insurance could generate tax savings.When you pass away, your estate will be responsible to repay the loan and can often settle all debt using death benefit proceeds from your insurance policy. Your family or beneficiaries will not have to repay any outstanding loan balance, and insurance proceeds will likely exceed what you took out as a loan.

3. Selling your policy

Four provinces (Quebec, New Brunswick, Nova Scotia and Saskatchewan) in Canada allow you to sell your life insurance policy to another person. When you sell your policy, the buyer will receive the premiums and the death benefit. The money you get from selling your policy may be taxed. The way it is taxed will depend on the type of policy, the money you paid into it, the amount you received from selling it and whether there was any cash value.

4. Employer-provided group life insurance

If your employer provides group life insurance coverage and pays the premiums on your behalf, those premiums are generally considered a taxable employment benefit. While the death benefit paid to your beneficiary is typically tax-free, the value of the employer-paid premiums may need to be included as taxable income while you are employed.

5. Cash value withdrawals from a permanent life insurance policy

Some permanent life insurance policies build cash value over time. If you withdraw funds from the policy during your lifetime, a portion of the withdrawal may be taxable. Specifically, if the amount withdrawn exceeds the policy’s prorated adjusted cost base (ACB), the excess amount is generally treated as taxable income and must be reported on your tax return as ordinary income.

Non-exempt life insurance and exempt life insurance in Canada

Understanding the difference between non-exempt life insurance and exempt life insurance in Canada can help you better see how taxes may affect certain policies.

Life insurance policies are considered non-exempt when they accumulate more cash value than permitted under the Canada Revenue Agency’s rules. The excess growth becomes taxable income each year.

On the other hand, exempt life insurance policies are ones with any investment or savings component that grows tax-sheltered within the policy, and a death benefit that is generally paid tax-free to the named beneficiary. Most life insurance policies in Canada qualify as exempt.

Term life insurance coverage is almost always considered exempt because it provides pure insurance coverage with no cash value components. Whole and universal life policies do include cash value or investment components and are therefore monitored to ensure they meet exempt policy rules.

How your family can benefit from tax-free life insurance

Overall, life insurance can help support your family’s living expenses. The money can help them maintain their quality of life and not have to worry about making ends meet. Especially if you are the financial breadwinner, consider how your loss of income would affect your family.

With our simplified issue, no medical life insurance plans, your family can get their payout tax-free, making it a little easier to cover any final expenses during a difficult time. Let’s look at an example. If you have a $300,000 life insurance policy and the death benefit is paid directly to your named beneficiary, they could potentially receive the full $300,000 with no income tax deduction, no probate fees related to the insurance proceeds and no requirement for them to report the payment as income on their tax return.

Is life insurance right for you?

Life insurance can benefit most people, and since the payout isn’t taxable in most cases, you will have peace of mind that your beneficiaries will likely be eligible to receive the full amount they are entitled to. Now that you know the answer to “is life insurance taxable in Canada?”, are you feeling ready to find the right life insurance for you? Visit our no-obligation quote page to get started today.

Insurability depends on the answers to medical and other application questions and underwriting searches and review.

Foresters, and their employees and life insurance representatives, do not provide, on Foresters behalf, financial, estate, legal or tax advice. The information given here is merely a summary of our understanding of current laws and regulations. Clients and prospective purchasers should consult their financial, estate, tax or legal advisor regarding their situation.