Life Insurance and Tax

The tax laws regarding life insurance in Canada are not terribly complicated, but there are certain tax strategies that use life insurance that can be very complex.  It’s always recommended to consult your certified tax professional for any tax matter. This article will discuss the basic components of taxes and life insurance and they are basically broken down into two main areas; the payments that are made at death (death benefit proceeds), and the payments that are made while living.

Tax Treatment of Death Benefit Proceeds

When the insured person dies, the life insurance a claim for the death benefit is made by the beneficiary (with the help of an advisor). Typically there is a lump sum benefit and it is not subject to income taxes, federally or provincially.  In Canada there isn’t a tax deduction on insurance premiums, so the proceeds from the death benefit are not considered income nor are they taxable in any way.  If an arrangement is made where the proceeds are held by the insurer and paid out in installments, then a portion of the installments are taxable when they are received.  To be more precise…the interest and other investment income that the insurance company has grown and added to the withheld proceeds is the only taxable portion.  The original proceeds or the Average Cost Base (ACB) is not taxable.

Tax Treatment of Proceeds While Living

A life insurance policy can be used as a tax sheltered investment instrument (i.e. Whole Life or Universal Life).  The policy holder deposits more than that minimum cost of insurance in hopes or accumulating a cash value.  The gains on the invested value are tax-deferred, so if the policy is cancelled any growth over the ACB (amount deposited) will be subject to tax in that year.  Currently, policy holders are given the option to pledge the cash value of their policies as security for a loan.  This loan can be used for retirement income while the value in the policy continues to grow tax-deferred.  The loan + interest will be paid back to the bank upon death but the loan proceeds that the policy has used for income were not taxable.  This strategy is called an insured retirement plan and an investor should always consult with a tax professional with your insurance professional before implementing such a strategy as there are many pitfalls to consider.

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