Life insurance is one of the most essential ways to provide financial peace of mind for you and your family. Whether you have either of the main forms of life insurance in Canada — term life and permanent life — part of that peace of mind comes from the life insurance payout guaranteed to beneficiaries upon a life insurance holder’s death.
But how is that life insurance payout impacted come tax time? Let’s take a closer look.
First, the good news. Much of what will be passed down from your life insurance policy is not subject to income tax for your beneficiaries, no matter the size or the type of insurance policy. In fact, the Canadian government maintains that most inheritances, including death benefits, and other financial gifts aren’t considered forms of income.
This also applies to the estate inheritance tax in Canada. Heirs or beneficiaries aren’t responsible for paying the government; the estate itself pays.
That’s part of the reason why it’s important to designate a beneficiary of your life insurance policy. If not, your estate technically becomes the policy beneficiary and your death benefit may be taxed.
It can get a bit tricky if your estate is the beneficiary or if you designate a beneficiary who dies before the life insurance policyholder. Other taxes may come into play, such as estate administration taxes, as well as probate and settlement fees and expenses.
In addition, if there is no will when someone dies (referred to as dying “intestate”) each Canadian province has its own guide on how assets are divided and when.
When there is a beneficiary, your life insurance policy is tax-free and paid out in a lump sum that can be used for a variety of things, including paying a mortgage and paying off debts. The death benefit has the large benefit of replacing your income so your family is financially comfortable following your passing.
The tax-free life insurance payout can also support children and other dependents, as well as a charity of your choice.
Many beneficiaries can also use the benefit to cover funeral expenses or protect additional assets. You can also name multiple beneficiaries on your life insurance policy whom you would like to be protected after you pass away.
The bottom line: When you name a beneficiary for your life insurance, they will not need to report the payout on their Canadian tax return as taxable income.
Most Canadians either have term life insurance or permanent life insurance policies. Term life insurance has designated term lengths, commonly 10 years, 20 years, 25 years, or 30 years.
It is almost always more affordable than permanent life insurance, which is a policy that may last your entire lifespan after you sign up for a policy; you won’t have to renew after certain term lengths.
Permanent life insurance, also called whole life insurance, includes avenues for investment within your policy, while term life does not.
Your permanent life insurance policy gives you the option to accumulate cash value as you pay premiums. That cash value can be invested in a way to earn interest and grow over long periods of time.
While you have the option to keep your permanent policy unchanged throughout your entire life, you also can terminate or surrender the policy.
When you do so and get the policy’s accumulated cash value, you must pay taxes according to how much that investment’s value has increased. That interest would be taxable income as well to your beneficiaries if they received any of the policy’s interest earnings along with the separate death benefit.
If you used a life insurance policy as loan collateral (an option in permanent life insurance), your beneficiary will have to pay taxes on a loan balance greater than what was paid into the life insurance policy. Additionally, if you sell your policy to another person, what you receive from the sale will be taxed.
The tax approach for that situation depends on how much you paid into the policy to begin with, the type of life insurance policy, what you received from selling, and if there was cash value associated with the policy.
Four Canadian provinces let you sell a life insurance policy to someone else: New Brunswick, Nova Scotia, Quebec, and Saskatchewan.
If beneficiaries need to report life insurance benefits to the Canadian Revenue Agency, the process is relatively easy.
For the permanent life insurance interest earnings, an insurance copy will send a T5 slip to the beneficiaries, who will report the earnings on line 121 of the return.
But you can make things go smoothly through a few easy steps. Life insurance is often a vital part of effective estate planning. The best first step, again, is designating beneficiaries with your insurance company. This allows your beneficiaries to avoid responsibility for most debts and other costs upon your death.
Settlement of an estate generally speeds up when there are named beneficiaries, meaning your death benefit will go to those you wish faster and easier. The death benefit from life insurance can also help beneficiaries pay for everything from owed income taxes and capital gains income taxes and more that is tied to an estate.
From the moment you consider a life insurance policy to the time your established death benefit pays out to beneficiaries, it can be vitally important to get help making sure your policy meets your individual needs and helps protect your loved ones.
Sim Gakhar has over a decade of experience in insurance, investment, and life insurance planning for clients throughout Ontario and British Columbia. Gakhar is a trusted partner in your and your family’s financial wellbeing, especially when it comes to developing the best life insurance policy for you and assisting with any tax issues that arise.
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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