A Canadian life insurance policy can be used to pay for certain estate taxes. Some policyholders may find this option to be the best way to pay their debts and taxes, preserving their other assets for their beneficiaries.
Navigating taxes around estate planning requires a strategy to ensure your beneficiaries receive as much of your assets as you desire. In this article, we’ll discuss the different life insurance policies and how they can be used for your future estate tax planning.
There are two types of life insurance, term and permanent. Each includes a death benefit that can be used when planning for estate taxes; however, term life insurance will only pay out a death benefit if the policyholder dies during the contract’s validity.
Term insurance is a policy taken out for a set amount of time, usually in 10-, 15-, 20-, or 30- year increments. Individuals can renew their term insurance once it expires, but the premium will adjust according to their age, health, employment, and a variety of other factors.
Term life insurance policies are straightforward contracts that offer a death benefit to beneficiaries if the policyholder dies while the policy is in effect. If the policy expires while the individual is still alive, there are no benefits and the contract simply ends.
The second form of life insurance is permanent life insurance. This includes whole life, universal, and variable life insurance policies. These insurance policies last until the death of the policyholder.
The premiums for permanent insurance are higher than for term life insurance, but the payments are also fixed and will not change due to age, a change in health, or other factors. Permanent life insurance also has a cash value component which grows tax-free during the policy.
Ontario does not currently have an inheritance tax. When someone dies, however, there are income taxes and capital gains taxes that must be paid. Additionally, there is another fee called an estate administration fee, or probate fee, which must also be paid to the Ontario government.
Even under death, we are still liable for our income taxes. The deceased will have to pay taxes for their last year of life. Typically, the estate executor and/or Power of Attorney will take on this responsibility.
The amount owed to the CRA can be paid out from any of the deceased’s assets, including their life insurance death benefit if it is part of the estate. Click here to learn more how death benefits helps the estate.
Upon death, a capital gains tax will be charged on 50% of all capital gains on the deceased’s property. This means that if the deceased’s summer home has appreciated $20,000, the estate will owe taxes on $10,000 of that gain.
The exception for this tax is if it was the deceased’s primary residence. Primary residences are not affected under this taxation rule and can be transferred to the deceased’s spouse or direct beneficiary without issue.
If that beneficiary were to sell the inherited property, however, they would be liable for taxation on half of the capital gain.
The probate fees on an estate are based on the total value of an estate upon death. In Ontario, the probate fee is $5 for every $1,000 for assets up to $50,000. Over $50,000 worth of assets would be charged $15 on every $1,000.
Aspects that are not included when calculating the probate fee include gifts you gave to others while alive, life insurance death benefits given to a living beneficiary, other benefits (such as RRSP or TFSA) given to specified beneficiaries, and property owned jointly with another individual. In the latter case, the property is passed directly to the surviving owner and does not have to undergo the probate process.
Investment and insurance professional Sim Gakhar is experienced when it comes to navigating life insurance for estate taxes. Insurance agents like Ms. Gakhar know the ins and outs for maneuvering one’s death benefit to pay for estate taxes.
Typically, there are two ways to do this. First, the insured can name a living beneficiary on their policy and speak to this beneficiary about their wishes for using a part of the death benefit for their estate taxes.
If the insured feels that their wishes may not be respected by the beneficiary, they could choose to name their estate as the life insurance policy beneficiary. This opens up the death benefit to more risk of being targeted by creditors, but it does ensure that the benefit will be used to pay any debts, fees, or taxes owed by the estate.
The death benefit from your life insurance policy can also be used to pay off liabilities such as mortgages or car loans. Most individuals take out their life insurance policy because they hope to financially protect their loved ones. By paying off these liabilities, you ensure that your physical assets are paid in full and can be thereby be passed down to your selected beneficiaries without issue.
Another use for the insurance death benefit is to establish a fund for an individual you want to continue to support after your passing. This could be any loved one, an underaged child, or even a child with a disability who needs assistance with daily care.
Finally, you can also use your insurance death benefit to donate to charity. Charities can be listed as the primary beneficiary or one of the multiple beneficiaries on a life insurance policy. This moves their portion of the death benefit directly to the organization, bypassing the need for an estate executor or trust executor to move and donate the money on your behalf.
Each policy and estate is unique, so it’s important to consult with a professional before deciding how you want to use your life insurance for estate tax planning. Schedule a call or appointment with Sim Gakhar this week to have your options laid out and make the most well-informed choice for your future.
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