How to use life insurance for tax and estate planning

This article was originally published on March 14, 2024, and was updated on February 6, 2026.

A life insurance policy can be an integral part of tax and estate planning. Not only does it provide a financial safety net for your loved ones after you pass away, but it can also be a versatile tool to manage finances while you’re living, particularly from a tax planning perspective. 

How? The death benefit is tax-free. This means your beneficiaries receive the full amount without paying additional taxes. In other words, it’s an excellent way to transfer your wealth to the next generation without spending it on taxes or other fees. 

Let’s explore how you can use a life insurance policy for tax and estate planning. 

What types of life insurance can I use for estate planning?

There are several types of life insurance you can use to plan your estate before you pass, including:

Term life insurance: When you die, your beneficiaries can use the tax-free death benefit for anything they wish, including mortgage payments, final expenses, income replacement and taxes incurred after your death. However, insurance coverage ends at the end of the specified term, so it may not be the best long-term strategy for wealth transfer.

Permanent life insurance: These policies are typically better for tax and estate planning because coverage lasts for your entire lifetime and comes with a cash value that grows tax-deferred over time. 

• Whole life insurance has fixed premiums and a guaranteed cash value you can borrow against while you’re living.
• Universal life insurance provides more flexibility in premiums and has the potential for higher cash value accumulation, depending on market conditions. 

How can I use life insurance for estate planning?

There are a few ways you can use a life insurance policy for estate planning. Here’s how its tax-deferred growth, tax-free loans and withdrawals can enhance the value of your estate while offering financial flexibility. 

Tax-deferred growth

The cash value in whole and universal life insurance policies grows tax-deferred, which means you don't pay taxes on the growth as long as the money stays in your policy. You will only be taxed when the funds are withdrawn. 

Whole life insurance offers stable growth with fixed premiums, while universal life insurance provides more flexibility to choose how the funds are invested and potential for higher returns based on market performance. 

This tax-advantaged growth makes these policies useful tools for saving money in a way that's not immediately taxed, offering a significant benefit over regular investment accounts where taxes can reduce your annual returns.

Also read: Is life insurance taxable in Canada?

Tax-free loans and withdrawals 

Permanent life insurance policies allow for tax-free loans and withdrawals. This means policyholders can borrow against the cash value of their policy without facing immediate tax implications, provided the policy remains in force. 

Withdrawals up to the amount of premiums paid are also tax-free. This feature can be particularly useful for managing estate liquidity and tax liabilities, enabling a more flexible, tax-efficient transfer of wealth to surviving loved ones. For example, if your loved ones face taxes or debt after your death, they can leverage this feature to cover the costs without incurring additional taxes. 

How does life insurance work for estate liquidity and equalization?

Life insurance increases an estate's liquidity by providing a tax-free cash benefit upon the policyholder's death. Liquidity in finance means having access to cash or assets that can be converted into cash quickly, which is crucial when immediate expenses need to be covered. 

Beneficiaries can use this payout to settle taxes, debts, and other immediate financial obligations without the need to sell off assets like homes or businesses to cover these expenses. This ensures the estate can meet its financial responsibilities on time without losing valuable assets or incurring additional costs.

Life insurance can also be used for estate equalization, which involves creating a fair balance among beneficiaries when the estate's assets are hard to divide equally. This strategy is especially useful in scenarios with significant non-liquid assets, such as a family business or real estate.

How much life insurance do you need for estate planning? 

How much life insurance you need depends entirely on your goals and what you want to leave behind for your loved ones. A rule of thumb is to use the DIME method, which adds up your existing debts, income, mortgage payment and education expenses. The idea is to have enough to cover all of that and more. 

For estate planning, you should also consider any taxes your loved ones might face, for example, capital gains tax on a cottage or business. You’ll want your death benefit to be able to cover it all and ideally more. 

Also read: How much life insurance do I need in Canada

The bottom line

Life insurance is an important part of both tax and estate planning, offering benefits like tax-deferred growth and increased liquidity. These advantages make it essential to secure your financial future and ensure your estate is managed according to your wishes after you pass away. 

To make the most of life insurance in your financial strategy, consult with a financial advisor. They can help you find a life insurance plan that fits your unique needs and financial situation, ensuring you and your loved ones are well-protected.

For information about insurance and taxes, visit our insurance tax guide.

Also read

• Filing Canadian taxes: Everything you need to know
• Life insurance for chronic illness – what you need to know
• The biggest life insurance myths in Canada
• Can you take out life insurance on anyone?
• You may no longer have enough life insurance thanks to the capital gains tax hike