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, 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) 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.
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