Are Inherited Life Insurance Proceeds Taxable?

General life insurance policies paid out to living beneficiaries are not subject to Canadian income tax; however, if you have not named living beneficiaries or instead named your estate as the beneficiary, then your death benefit is subject to certain taxes.

This guide discusses when life insurance proceeds are taxable, as well as how you can avoid taxes through designated living beneficiaries. For additional inquiries not covered below, reach out to Sim Gakhar with any other insurance questions.

Non-Taxable Life Insurance Proceeds

If you own a straightforward Canadian life insurance policy, your death benefit will be paid out tax-free to your beneficiaries. These beneficiaries must be living entities or organizations – not your estate. Be sure to check the stipulations of your insurance policy with certified Ontario insurance agent, Sim Gakhar.

Living Beneficiaries

If a policyholder has designated living beneficiaries on their policy, the death benefit would be paid out to them tax-free. This stays the same regardless of policy size or who you named as the beneficiary.

Beneficiaries and heirs in Canada are not required to pay estate inheritance or death taxes – these are paid out by the estate itself to the government.

Taxable Life Insurance Proceeds

Life insurance proceeds are taxable if the death benefit is paid out to the policyholder’s estate. Another situation initiating tax collection is if the policyholder had taken out a loan using the insurance policy as collateral before their death. Let’s take a look at examples of both situations.

No Beneficiaries

A policy might not have a designated beneficiary for three reasons. First, the policyholder may have outlived the first beneficiary or died with them, as is the case of some car accidents or natural disasters.

Second, the policyholder may have been in the process of selecting a new beneficiary but died before doing so.

Third, the policyholder may have purposefully selected their estate as their life insurance beneficiary instead of a relative or friend.

In all cases, when there is no living beneficiary selected, a life insurance policy will become part of the estate upon the policyholder’s death. When the death benefit moves from an insurance policy through an estate, it is subject to an estate administration tax, called a probate fee.

Ontario law will then look to see if your estate includes a will that designates an estate representative or any general beneficiaries.

If you do not have a will with either of these appointees, Ontario law will appoint their own trustee through an application for a certificate of appointment of estate trustee without a will. This certificate appointment will cost about 1.5% for any estate valued at or above $50,000.

If your death benefit becomes a part of your estate, it may also be used to pay your debts and death taxes before being dispersed to any living heirs. These include taxes on any capital gains on property, taxes on RRSP or RRIF withdrawals, and taxes you owe from the last year you were alive.

Policy Loan Collateral

If you have a permanent life insurance policy, such as whole life insurance, your policy will include a cash value component. Policyholders have the option of taking out a loan through their insurance company while they are living, using their cash value as collateral.

This loan is usually offered at an interest rate lower than those of competing institutions, so policyholders may take advantage of this loan to face a large upcoming expense. This loan is expected to be paid back to the insurance company; if not, it can reduce or eliminate the death benefit altogether.

If the policyholder dies while paying back this loan, the remaining death benefit is subject to both the interest rate and the owed amount of the loan. Beneficiaries may find themselves with much less after everything is paid back.

Reporting Insurance Proceeds on Your Taxes

If you are a beneficiary receiving the death benefit of a Canadian life insurance policy, you do not need to report this as taxable income on your tax return.

If your death benefit are subject to interest earnings, the issuing insurance provider will send the beneficiaries a T5 slip. This T5 slip reports the interests acquired from the policy, and this is the amount the beneficiary will report on line 12100 of their personal tax return.

If the policy was purchased before 1990, the beneficiary would have to request a report of yearly accumulated earnings by requesting it from the insurance provider in writing.

Navigating taxes and insurance policies can be a complicated process. Don’t risk making an uninformed decision – let investment advisor and insurance agent Sim Gakhar assist you with your Ontario insurance needs.

Benefits of Tax-Free Insurance Proceeds

When you die in Canada, your RRSPs and any real estate you have is subject to different forms of tax. Investments are also affected, but life insurance policies have sought protection against the paws of the tax collector.

A life insurance policy can help prepare your family for funeral costs, mortgage payments, financing education, and paying daily living expenses. Did you know in Canada the average cost of a funeral ranges from $5,000-$15,000?

You’ll want to make sure you leave your beneficiaries in good hands to avoid any financial pitfalls or surprises after your death. They can use this un-taxed income to pay outstanding debt and tie up any financial loose ends that would have otherwise proved to be a burden.

By choosing beneficiaries for your Canadian life insurance policy, you are guaranteeing them a generous death benefit that will go straight into their pockets without tax interference.

Choosing the Right Life Insurance Policy

Top Canadian life insurance policies include term policy, whole life policy, universal policy, and variable life insurance. Each one has its caveats and inclusions which make them better for some people and less helpful to others. Choosing your policy means determining what you will leave your loved ones.

Sim Gakhar continuously sits down with her clients to discuss their policy needs, inclusions, tax concerns, and any other inquiries they may have. Reach out to her today to learn more about the best life insurance policy for you.