Life insurance is a great tool to provide your family with security. Upon your death, they are paid a death benefit, using it as a way to grant your final wishes and relieve any financial pressures they may feel with your absence. Because most income and inheritance are accompanied by tax liabilities, many may be wondering if their beneficiaries will have to pay taxes.
Below, we’ll discuss the benefits of life insurance for your estate and take a look at how taxes work when your death benefit is transferred to your loved ones. We’ll also discuss a few ways to avoid taxes on your estate and your policy, guiding you toward a security net that works for you.
Life insurance is a way to secure assets and help loved ones financially in the event of your death. The last thing that policyholders want is to lose value on their death benefit due to taxes. Luckily, death benefits received from a life insurance policy are not taxed and beneficiaries will not have to claim their taxes.
As long as your death benefit is passed on to your selected beneficiary, they will not have to pay taxes and can use that amount to reduce debts from your estate or relieve the financial stress that comes from everyday expenses.
Life insurance is not taxed as long as a beneficiary is named. Even though you may have beneficiaries for your estate tied into your last will, click here to know about how to create a will, they are not the same as beneficiaries for your life insurance policy. Those for your life insurance policy are separate and cannot be changed with your last will.
When creating a life insurance policy, it’s critical to select a beneficiary, as failure to do so could transfer the death benefit into your estate where it is subject to taxes. Not only do you need to appoint a beneficiary when signing up for your plan but also keep your plan up to date, adding a new one if your chosen beneficiary passes.
Not all life insurance policies are the same. There are some that can accumulate a cash value over time, which could be subject to taxes. Whole life insurance policies give policyholders the option to collect a cash value over time, coming from the premiums paid to keep the insurance policy active.
When cash value collects interest, the interest is taxed. In most cases, cash value won’t start to collect significant interest until much later, taking years to accumulate a substantial amount. If that’s the case when your death benefit is passed to your beneficiary, then they will be taxed on the interest earned and nothing more.
It’s not just cash value that could add taxes to a life insurance policy. Another way that taxes could accumulate is with failure to appoint a beneficiary. With no beneficiary named for your life insurance policy, the death benefit automatically becomes part of your estate. There, it will go through probate and get taxed, reducing your beneficiaries’ overall inheritance.
Because life insurance benefits can end up awarding a substantial amount to your beneficiaries, you may be wondering how they can go about reporting it. According to the Canadian Revenue Agency, beneficiaries will not have to report their earnings on their tax return, unless otherwise specified.
When an amount is owed in taxes, beneficiaries will receive a T5 slip from the Canadian Revenue Agency detailing the amount of interest they need to pay on and the total taxed amount owed. These interest earnings will receive a tax rate and be added to the overall income of the beneficiary.
Because the amount received is not taxes, a lot of policyholders use life insurance as a way to offset taxes put on their estate. This will reduce the tax amount and ensure that their beneficiaries receive more of its value and less of its debts and fees.
The cash value that accumulates over time is useful for several reasons, both while the policyholder is alive and upon their death. As a policyholder of a whole life insurance plan with cash value, you can withdraw from your cash value or take out a loan to borrow from it, using a low-interest, tax-free way to access funds when you need them.
Upon your death, your beneficiaries will also get some of the cash value, able to use it to further secure your assets and their future without you. The only thing they will get taxed on is the interest collected, which is not always a larger amount.
You also have the option to cancel (surrender) cash value of your whole life insurance policy if needed. In this way, you get the entire cash value of your policy and will no longer have a life insurance plan in place. When you surrender your policy, you’ll receive the cash value, most of which will not be taxed.
Just like in the case of your beneficiaries, the amount will only be taxed if there are interest earnings. Just like your death benefit, you’ll receive a document from the Canadian Revenue Agency along with the amount that you’ll need to pay on your tax return.
Looking at all of your options when it comes to securing your assets and your loved ones can get confusing, leaving you unsure which option or suite of options is the best for your situation. Instead of going at it alone, it’s recommended to work with a professional, one that has a range of knowledge in personal finance and investments.
Sim is one such individual, with years of experience creating the best security net for those that need it the most. After discussing options, she can help you customize your security and secure your assets and your loved ones according to your needs. If you’re in the market for protection from the unexpected, give Sim a call, and take steps to secure your assets today.
My husband and I had the pleasure of getting our life insurance through Sim Gakhar. She is professional, attentive, detailed-oriented and knowledgeable. Sim is reliable and trustworthy – from selecting the right product to providing medical records and payment process – she made it super easy. She is punctual and flexible – she always came to our home at our schedule. She ALSO helped with closing one of our older insurance policy that wasn’t working for us. We highly recommended Sim, she is definitely one of the best in the industry.
Tharmila RajasingamCo-Founder | Realtor
Sim helped me and my wife replace existing Life Insurance and Critical Illness policies that weren’t meeting our needs. Her knowledge of Canadian Insurance policies and providers is excellent. Her approach was very consultative, ensuring that she understood our situation & goals, and never overselling. We were presented with several options and given time to make the best selection. Her relationships with coverage providers ensures that the process goes smoothly. I highly recommend her.
Jim MonteathIT Consultant
It has always been a pleasure conversing with Sim. She is always available, and always happy to provide you the best solution to suit your needs. One thing that makes Sim outstanding at what she does is her deep understanding of various products and how they fit within the goals of the client. It has truly been amazing 6 years since I have known Sim. Not only have I received appropriate coverage, but also was able to set up a plan for the estate. Thanks, Sim, and to anyone looking for a financial advisor or an estate planner or have any insurance needs, Sim is the person to go to. Thanks, Sim.
Sim helped us with a life insurance policy. Her communication systems and processes and her ability to stay in touch, explain things, and move things along is as professional and streamlined as I’ve ever seen. She was an absolute pleasure to work with and has helped our family secure our financial future!
Jonathan CarterCPA | CMA
Sim has been our go to person for insurance over the last 11 years. She is nothing short of professional, caring and always looking out for our best interest. The great thing is she will always be available to answer questions and provide insight on how the decisions you make today, will impact your future tomorrow.
Sim is a thorough and learned professional. It was a great experience working with her, to get customized insights, advice in making my insurance and investment decisions. She handled the end-to-end process with ease, especially during this challenging time, and went the extra mile so I could complete everything remotely. I would definitely recommend her and look forward to working with her for future investments.
Manav GhaiSenior Product Manager
Sim is a very knowledgeable and experienced professional not just for excellent & creative insurance solutions but probably the best financial planner that you will ever meet. We have known Sim for almost the past 2 decades and all we can say she conducts her business with integrity.
Neil RamchanderSales Manager
Sim is extremely knowledgeable, patient and helpful. She helped us to put together a plan that suited our needs very well. I think we were very lucky to find Sim.
Rick MateljanPrincipal Owner
I had the pleasure of working with Sim on selecting the best life insurance policy fo me. I had met with several advisors prior to meeting Sim and she definitely stands out as one of this best in the space! It’s very refreshing to see how she personalizes her approach to each person/product and makes sure you are well informed and comfortable before making any financial decisions.
She is constantly learning and paying it forward through her involvement and leadership in international community events. I am confident that Sim will help me make decisions in my best interest and I am excited to work with her in the future!
Sanveer DhanjuProduct Analyst
Sim is very knowledgeable and experienced person who not only help me with my life insurance and retirement planning needs, but also help my clients with their tax and retirement planning needs on very timely basis. I highly recommend her if anyone needs insurance and investment advice.
Olga Sokolova CPA, CA, LPA
Helping business owners and self employed professionals grow retained earnings tax-free, pass more wealth to the next generation, and protect their biggest asset – themselves, the key person of the business.
When it comes to life insurance there really is no time that is too soon to get covered. And, this is because the younger you are, the cheaper those premiums are going to be. Not only this, but you are probably healthy right now.
If you wait until something bad happens, you will not only without a doubt face higher premiums, but you might not even be able to get covered at all.
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