Life Insurance for Inheritance Tax Planning

You can use life insurance with financial planning to offset taxes on inheritances and cover other fees after death. Because life insurance provides an immediate, untaxed payout, it is easier for heirs to leverage these funds to handle costs immediately following the death of the insured.

Continue reading to learn how inheritance tax is applied in Canada and how you can plan your estate to dampen these costs. Because life insurance policies are an easier way for beneficiaries to access funds, we also explain how you can use them when planning for inheritance taxes.


How Inheritance Tax Applies in Canada

Canada does not have a specific “inheritance tax” that applies to any assets of the estate inherited by an individual.
Instead, the Canada Revenue Agency does a final income tax for the deceased, and taxes are calculated on the assets of the estate as a sale. Any taxes incurred are taken from the estate before the executor can distribute assets as laid out in the will.


Life Insurance and Inheritance Tax

Life insurance is a fantastic tool when planning to balance out any tax imposed on inherited assets. These policy payouts usually go directly to the beneficiary without passing through the estate of the deceased, so the inheritance of a policy does not incur any tax fees.

This makes a life insurance policy an extremely attractive way to plan for estate offsetting inheritances fees such as:

  • Taxes on the deemed disposition of capital property
  • Taxes on significant capital gains
  • Probate fees
  • End-of-life expenses

Because the life insurance policy is paid out immediately and in full, inheritors can use the funds to cover necessary expenses and balance out inheritance taxes.


Estate Planning for Inheritance

When you are planning for inheritance tax you need to construct a full plan for your estate. This needs to cover any actions you want your executor to take on your behalf, including the distribution of assets.

During this period you should also research how you can protect your assets and limit taxes and fees placed on them. Try to keep any outstanding debts low, and find an avenue to cover those amounts if you die before repayment.

Keep an eye on any assets that you have, including where they are held. For example, assets in the United States valued over $60,000 will trigger an assessment of the value of your assets worldwide. If this is larger than $11.2 million then your estate could see another estate tax imposed on the United States asset. It would be worth selling or relocating this asset.

Effective planning creates a plan that minimizes the taxable amount of your estate and provides a way to offset any imposed taxes.


Keeping Life Insurance and Other Assets Out of Probate

When paid out as intended, life insurance policies are not taxable. This means that as long as the life insurance policy is paid directly to the beneficiary it remains intact.

Life insurance policies and other financial accounts that allow you to list beneficiaries are best managed when they are kept out of your estate and the probate process. Make sure you list beneficiaries on your account and keep these names updated with major life updates like marriage, divorce, the birth of children, and death.

If the beneficiary of a policy dies before the insured and the policy is not updated then it will go to the estate. Naming a contingent beneficiary can prevent this from happening, but it is best to keep in the practice of updating financial documents every few years.


Planning for Inheritance Tax with Life Insurance

As long as you keep life insurance out of probate, you can pass on an untaxed sum for your beneficiaries to use to recoup amounts lost to estate taxes, probate fees, and other after-death costs.

Approaching this subject with a life insurance plan is effective, but you need to take the time to ensure you are purchasing the right type of policy with the right amount of coverage.


Different Types of Life Insurance for Inheritance Tax Planning

There are two main types of life insurance policies that you can leverage when planning for after-death expenses.

Term life insurance policies are the cheaper option, but they only provide coverage for a certain period. Once you reach the end of the term the coverage ends, and you either need to purchase a new policy or just let it go.

Term policies are best used for debts that will fall off as time passes or to provide supplemental coverage until you can get your finances in better order.

Permanent policies (including whole life and universal life) are the preferred option when planning for inheritance tax and providing funds for your heirs. These policies do not expire as long as you keep on top of premium payments, and you can have more flexibility in coverage options.


Determining How Much Life Insurance is Needed

To determine how much life insurance coverage you need when planning for inheritance tax you need to look at the value of your assets and any outstanding debt that you have, as well as the potential timeline for your finances. You should also consider other uses for the policy.

If you are purchasing a life insurance policy for the sole purpose of covering estate taxes and fees then it needs to be enough to cover:

  • Debts
  • Estimated taxes
  • Probate fees

You can mix policy types to cover different needs. For example, it makes more sense to cover a mortgage that will fall off after 30 years with a term policy covering that period. Putting that amount into a whole life policy increases your premium unnecessarily, and it leaves you footing that bill if you outlive your mortgage.

If the other members of your family rely on your income then your life insurance policy should also be sufficient to replace your income.


Final Thoughts

The more that goes into your estate, the more complicated this scenario gets. Sim Gakhar has the expertise to help you plan ahead and ease the financial burden on your loved ones after your death.

Contact Sim today to learn how to leverage life insurance when planning for inheritance taxes.


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