Is life insurance taxable in Canada?

Purchasing a life insurance policy can help reduce the financial burden and stress off your loved ones, but are there any tax implications you should know about beforehand? Are life insurance proceeds taxable in Canada? The short answer is usually no. The long answer, however, is more complex. 

Do beneficiaries pay tax on life insurance in Canada?

Your life insurance beneficiaries typically won’t need to pay income tax on a death benefit from your policy. Like financial gifts and inheritances, most life insurance amounts are non-taxable under the CRA. While you can use the money as income replacement or pay off your mortgage, you don’t need to report the death benefit as additional income on a tax return. 

Tax implications: naming your estate as your beneficiary

On the other hand, there could be tax implications if your death benefit goes towards your estate instead of directly towards a person. This can happen if you list your estate as your beneficiary or all your named beneficiaries die before you do. 

In this case, the amount could be subject to tax, and there may be additional settlement costs (e.g. accounting, legal, executor fees) during the money distribution process. 

Therefore, it’s a good idea to appoint beneficiaries directly on your life insurance policy. By doing so, you can prevent added fees and taxes and speed up the overall settlement process. 

Is the cash value of life insurance taxable in Canada?

Some permanent life insurance policies have a built-in cash value you can use for investing. Though, only consider this option if you’re maxing out your TFSA and RRSP every year. 

If you decide to surrender your policy and withdraw the cash value, you will pay tax on your earnings. And when you die, if your beneficiaries receive any money from say interest or dividends from your life insurance policy, they will pay tax on the amount. 

If you do need to pay taxes, your insurer will send a T5 slip, outlining the amount you owe to the government. You can then simply report the earnings on line 121 of your tax return. 

However, you don’t need to report your cash value earnings as income while they remain in the policy as long as your earnings stay within the limit (consult your insurer for an exact amount as it can differ depending on your policy and legislation). Life insurance investments grow under a tax-sheltered basis and nearly all policies in Canada are exempt from taxation until the money is withdrawn. 

Summary: taxation of life insurance 

Scenario	Taxable?
Your beneficiaries are named on the policy	No
Your estate is named as the beneficiary	Yes
You surrender your cash value	Yes (earnings only)
Your cash value is paid out after death	Yes (earnings only)
Your cash value remains in policy	No

Is life insurance tax deductible in Canada?

On the other hand, you may be wondering if life insurance is tax deductible in Canada. Can you write off your life insurance premiums when filing taxes? Speaking from an individual standpoint (not for businesses), the answer to this is no. Well, not usually. 

There are a few scenarios in which part of your payment may be considered tax deductible. Let’s say you use your life insurance policy as collateral for a loan or you borrow money against your cash value. If you use the loan to earn business or property income, you could possibly get a deduction on your taxes – be sure to consult a tax professional.

If your policy is donated to a charity, you won’t receive a tax deduction, but you can receive a tax credit instead. Unlike a deduction which decreases your taxable income, a credit decreases the amount you owe to the government directly. 

Keep in mind that naming the charity organization as your beneficiary isn’t the same as donating the policy. If you simply name them, you won’t personally receive a tax credit, but your estate will receive one for the donation after your passing. 

Summary: tax deduction of life insurance 

Scenario	Tax deductible?
General circumstances	No
You use your policy as loan collateral	Possibly (consult a tax professional)
You borrow against your cash value	Possibly (consult a tax professional)
A charity owns the policy	No (tax credit instead)

The bottom line

So is life insurance taxed when paid out? And are life insurance premiums tax deductible? The answer to both questions is no, but there are a few outliers to be aware of. Keep in mind that this is only a general overview of life insurance and taxes – for more information on your specific case, be sure to consult a tax professional in Canada. 

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