Are Life Insurance Proceeds Taxable to the Estate in Canada?

Life insurance is often a top choice for those looking to secure their family. In the event of a death, the insurance policy will pay the family, giving them the financial support needed to live comfortably. While life insurance is a popular choice, there are many misconceptions that surround it, one of which is taxes.

Those that are looking to secure an insurance policy may be wondering if their beneficiaries have to pay taxes when they receive a death benefit. We’ll provide the answer to that question and guide you on ways that you can maximize your estate.

Life Insurance and Taxes

One of the main reasons why life insurance is a popular way to secure assets and pass them on to beneficiaries is due to the fact that they are tax-free. No matter what the size of the death penalty paid to your loved ones, they will not be liable to report them on their income and would not have to pay taxes.

All you have to do in order to prevent your loved ones from paying taxes on the death benefit they receive is name someone as a beneficiary.

This is the person that receives the death benefit, usually some that are close and trusted like the spouse or the children. As long as there is a beneficiary named, you can avoid taxes on most insurance policies, though there is one with an exception.

When Life Insurance is Taxable

Though most life insurance policies are tax-free, there is one that could be subject to taxes. Permanent life insurance can accumulate a cash value, coming from the premiums that you pay to keep yourself insured.

Over time, this cash value can add up, allowing you to withdraw from it, take out a loan, or allow it to accumulate. Upon your death, if there is a cash value accumulated in the whole life policy, your beneficiaries will only pay on it if there were interest earnings. The only part that taxes is the interest earnings, and the rest is tax-free.

This is not only the case with your beneficiaries but, also if you decide to withdraw or take a loan from your policy. There are some circumstances where you could be taxed on the amount your receive, including when the value of your cash value has increased.

Surrendering your Insurance Policy

Life insurance policies are not forever, allowing the policyholder to cancel them whenever they would like. While a typical life insurance policy can be cancelled simply by stopping payments, others with a cash value take a different set of actions.

One way is to surrender, collecting the cash value upon doing so. There are many reasons why policyholders would want to surrender, especially if they plan to use their cash value for something else. Whatever the case, when surrendering, the policyholder could have to pay taxes.

Taxes are required to be paid if the cash value increased since the initial investment, only added to the overage of the original value. In this case, the entire amount becomes taxable as income, something that all policyholders should consider before surrendering.

Reporting your Life Insurance Payouts

The Canadian Revenue Agency lines out simple rules when it comes to tax reporting. For those that receive benefits from a life insurance policy, there is no reporting to do unless there is a tax due to interest earnings. Your beneficiaries will not have to figure out whether or not there are taxes owed on their own.

If there were any interest earnings with your cash value and your beneficiaries are required to pay taxes on it, they will receive a T5 slip, which will explain the amount and how they can go about paying it.

Using Life Insurance to Boost your Estate Value

When you create a will, you can pass on your assets to your loved ones. While this is a great gesture that could keep them in a comfortable place for years to come, there is one thing to remember, your estate is subject to taxes.

These taxes are added to the value of your estate after deducting the value from the debts that you owe. That means that, overall, your loved ones could receive much less than you had hoped. One solution to overcome these taxes and reduce financial stress from debts is a life insurance policy.

The fact that life insurance policies are tax-free makes them a great way to reduce the amount lost from your estate due to taxes and the debts owed. It will ensure that your loved ones get the max benefit and won’t have to worry about paying fees.

Using a Trust to Avoid Taxes

A trust is a fund that can be used to avoid taxes on estates. You can create a will and add assets to a trust, selecting beneficiaries that will receive assets included in your trust upon your death. Funds tied into trusts are not subject to taxes in all circumstances, especially when they involved spouses and children.

Add a trust to your estate and transfer property or stock options to it to save on taxes. You can even choose the terms of the payout for your trust, choosing to pay your loved ones monthly for a set time or when they turn a certain age.

Find your Best Strategy to Avoid Tax on your Estate

Finding the best way to keep most of your estate away from taxes takes some planning. There are a number of ways to do so, though finding the right option for you depends on several factors. Instead of trying to figure it out on your own, give Sim a call.

Sim’s experience with financial planning, investments, and life insurance can help you find the perfect strategy to get the most out of your assets, passing them on to beneficiaries without financial stresses attached to them. It’s never too early or too late to find ways to secure your assets, planning now to have peace of mind in the future.