The cash value of a whole life insurance policy is taxable in certain events, such as when using the policy as collateral for a loan or if the policy is surrendered.
Whole-life policies are a great way to earn cash without taxation, but it is important to understand what events are taxable with your whole-life policy. Keep reading to uncover the tax benefit, what taxable events are (with examples), events that are not taxable, and how you can use the policy to deduct taxes.
Whole life insurance is popular in part because of its ability to stow away cash on a tax-deferred basis. This means that as long as you are not touching the money you put into the policy it does not incur taxes.
This is especially helpful when handing off the death benefit to a beneficiary. This lump-sum amount is not taxed, and it can be used to:
While this tax benefit exists, there are certain things to look out for that are taxable with a whole life policy.
A taxable event is any action taken with your whole life insurance policy that can incur taxes. These are not common, but you can expect a taxable event to trigger when you tap into the cash value of the policy or if you terminate the policy.
There are a few specific examples of taxable events relating to whole life policies, but you can contact your insurance company or insurance agent for a more extensive list.
Keep in mind that any time a taxable event is triggered your insurer will release a T5 slip to inform you (or your beneficiary) of the event.
When looking at taxable events there are a few terms you will see often.
The cash surrender value (CSV) of a policy refers to the internal value at a given point. This is equal to the accumulated amount minus a surrender charge, and it is the amount that would be paid out if a policy were terminated at that point.
The adjusted cost basis (ACB) is the cost of the interest in the policy. This number can be adjusted to include certain items, and it usually increases as premiums are paid into the policy.
A taxable event triggers when your cash value is accessed, most commonly when you withdraw from the cash value as a loan, initiate a non-reversible withdrawal, or surrender the policy.
Withdrawing from the cash value as a loan can be described as taking an advance against the death benefit. If you take an amount that exceeds the ACB of the policy, then you will trigger a tax event.
In this case, the amount borrowed that exceeds the ACB is what will be taxed, but the amount under is left alone. If you can borrow less than the ACB you will be clear of a taxable amount.
Withdrawing part of the cash value of your policy is something that you cannot reverse, and you cannot pay it back. Any payments after must meet the conditions set out in the contract to meet the tax-exempt status for the policy.
Regarding the portion that is withdrawn, a portion or even the full amount could be considered taxable. When the CSV is more than the ACB it triggers a taxable event. The amount that can be taxed is the proportion of the amount that is withdrawn compared to the total value of the policy fund.
Surrendering the policy is withdrawing the surrender cash value, which is the full amount of the policy less any outstanding loans and surrender fees.
When you pay taxes based on surrender you are covering the amount that your investments increased in value.
Whole life insurance policies are sought after because they provide many ways to access funds without triggering a taxable event, like using the loan as collateral or the eventual claim of the death benefit.
Because you do not need to pay taxes on these events, learning what differentiates them from taxable events is essential to using the cash value of your life insurance policy smartly.
Accessing the cash value of a policy without triggering a tax event is possible by keeping the CSV under the ACB.
When you pursue a loan that uses your policy as collateral, it is not often treated like a policy loan, and you are not subject to the same tax rules. This can give you an easy way to lock down money without incurring any taxes owed.
The largest tax-free event in a whole life insurance policy is the death benefit claim. This is a single payment that does not incur tax fees as long as it is paid out to the beneficiary.
At most, a beneficiary may be required to pay taxes on interest earned from the policy’s investments, but insurers are forthcoming with this information if it is applicable.
The Canadian Revenue Agency is responsible for handling any taxes related to your policy, and they work to make it easy for beneficiaries to receive the death benefit without requiring reports of any king.
Unless taxes are due, you do not need to report any amount for tax reasons. If taxes are due then your insurer will provide you with a T5 slip outlining the amount and the reason.
There are instances when the cash value of a whole life insurance policy is taxable, but it can be easy to work around or avoid triggering them.
Contact Sim Gakhar for a more in-depth review of the information or to find out what your options are for accessing the cash value of your policy. An experienced life insurance agent will have no issue showing you the ins and outs of life insurance and taxable events.
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