Do You Have To Pay Taxes On Inheritance From Life Insurance?

Over the span of a lifetime, some work to create a legacy. Even if they were not handed one themselves, some out there work hard to take care of themselves and their family, building up their assets with monetary gains, property, and more.

For those that work hard to support their family, there is never a better time than to start securing their futures, setting up a life insurance policy. Below, we’ll discuss some things to consider when setting up a policy with inheritance for your loved ones, including how you can avoid taxes as well.

 

Taxes and Life Insurance Inheritance

One of the key reasons why many choose life insurance when securing their life’s assets is because it’s tax-free. While there are some occasions when the taxes are added to the amount beneficiaries receive, most insurance policies pay out a death benefit that is not taxed.

When death benefits are taxed, it’s mostly due to a permanent life insurance policy that has an option to accumulate a cash value. These policies are set to last the remainder of the policyholder’s life and begin to accumulate cash value as each premium is paid.

Life insurance policies with a cash value option serve a number of purposes, most of which have to do with a small investment that is withdrawable. The ability to borrow cash from a life insurance policy is a great alternative to other loans, most of which come with high-interest rates.

As long as the amount withdrawn is not more than the initial value of the policy, policyholders or their beneficiaries, will not have to pay taxes.

 

Avoiding Taxes on Life Insurance

Even though life insurance inheritance is not taxed in most cases, there are some instances when it can be. To avoid taxes added to your estate, here are some key strategies to keep in mind.

 

Keep Beneficiaries Updated

When creating a life insurance policy, you’ll have to select a beneficiary that will receive an inheritance upon your death. All of those looking to create a policy are advised to do so mindfully, choosing someone that is trustworthy and responsible.

It’s not just about choosing wisely but also keeping beneficiaries up to date.  If beneficiaries die before the policyholder and a new one is not named before their death, the life insurance policy will automatically be added into their estate, where it is subject to taxes.

 

Keep Cash Value in Mind

The cash value that accumulates with some life insurance policies can add up over time. While this is a great nest egg, if left to grow too large, it can accumulate interest that is taxable. While it’s okay to set and forget investments, it’s worth it to keep up with the cash value, making sure it doesn’t accumulate taxable interest.

Policyholders can always consider withdrawing money from their cash value or taking a loan out. If they want to cancel, they can consider a surrender of their policy, using that as a way to collect their total cash value. As long as there is not an overage of value, there are no taxes on the cash received, which could be a good way to pay for final costs.

 

Consider your Estate Plan

An additional way to secure assets is with an estate plan using a last will. With a will, policyholders can make specific requests for their assets and plan their final wishes. As far as assets, they can name heirs, passing them along as they would like.

Unlike life insurance, an estate is subject to taxes, which could significantly reduce the overall value. It’s for that reason that those securing their assets tend to add an insurance policy to their plan, reducing some of the burdens that come from estate taxes.

To use life insurance to reduce estate tax, policyholders will need to appoint a beneficiary that is willing to use the death benefit in the estate’s best interest. They can use the received amount to pay for the policyholder’s final life plans and use the rest to reduce tax and debts so that the estate holds its value.

 

Tax Reporting and Life Insurance Inheritance

A lot of those that are receiving inheritance question what they will need to do when it comes to filing taxes. One good thing is that the Canadian Revenue Agency doesn’t require beneficiaries to report their life insurance inheritance unless otherwise specified to do so.

If you do need to pay taxes on the inheritance that you receive, you’ll receive a T5 slip, which details the amount of taxes that you will owe. If you do owe taxes, it will be due to interest earnings and not the entire policy. The only time the entire policy is taxed is if there is no beneficiary to receive it.

 

Consider Other Methods

There are other more complicated ways to reduce the taxes paid on an estate, including adding a trust to the estate and passing things like property and stocks to the spouse or children. This ensures that the estate goes through probate without them, reducing the overall tax rate.

While it’s not a complicated process, there is a lot that goes into it, and the combination is something you should work with a professional toward achieving.

 

Your Perfect Plan Awaits

Making plans to secure your life’s earnings can be difficult to manage on your own. There are many ways that you can combine options to reduce your tax liability and use a life insurance policy to give your loved ones a lump sum they can use to carry out your final wishes.

Though it might seem grave to talk about, Sim is a trained professional that will help you secure your assets now and into the future.

Using your assets, she can help you build a plan that will keep your assets and your loved ones protected in the event of your death. She can also help you maximize your investments, taking steps to grow what you have while you’re still here.

 

FAQs & Helpful Resources Regarding Life Insurance for Estate Planning