Everything You Need to Know about Life Insurance and Taxes

Life Insurance and Tax: Introduction

Life insurance is one of the most widely used life and living benefits insurance products, but many questions remain about its tax implications. Understanding how taxes apply to life insurance is crucial, especially given the involvement of the Canada Revenue Agency (CRA).

Life Insurance and Taxes: Key Financial Transactions

Life insurance tax topics span various financial transactions:

1. Paying life insurance premiums:
   A common question is, “Are life insurance payments tax deductible?” or “Are premiums for life insurance tax deductible?” Generally, for individuals, life insurance premiums are not tax-deductible in Canada. However, in corporate-owned life insurance, premiums may have certain tax implications depending on the structure and purpose of the policy.
2. Receiving a life insurance payout:
   Many ask, “Is life insurance taxable in Canada?” or “Is there a tax on life insurance proceeds?” In most cases, life insurance payouts to beneficiaries are not taxable, providing a tax-free benefit. However, complications may arise with corporate-owned life insurance if payouts are structured improperly.
3. Cashing out a life insurance policy:
   This applies to permanent life insurance policies, such as whole life insurance, which include a cash value component. While accessing the cash value is possible, any gains over the contributed amounts are subject to taxation.

Life Insurance and Tax Questions – Important to Consider

• Policy Ownership: Life insurance policies can be held by individuals (personal life insurance) or corporations (corporate-owned life insurance). Corporate-owned life insurance is often used for key-person protection, estate planning, or shareholder buyouts, making it a critical component in business strategies.
• Policy Type: Tax considerations vary by policy type. Term life insurance policies are straightforward with no cash value, whereas permanent policies like whole life insurance have both a death benefit and a cash value component, which introduces additional tax considerations.

Types of Individual Life Insurance

As briefly mentioned above, there are two different policy types:

• Term life insurance is the simplest and cheapest life insurance policy. It only offers life insurance protection for a predetermined period of time such as 10, 20 or more years. In this case it is called Term 10, Term 20, and so on. If a policy holder passes away during this period of time, a beneficiary receives a pre-determined amount of funds. In exchange for this, the policy holder pays monthly or annual life insurance premiums. If nothing happens during the pre-determined period of time, meaning the policy holder does not pass away within 10 or 20 years or other period of time, the policy ends. Getting a new term life insurance policy means higher rates since the policy holder will be older (premiums rise with age and health decline).
  
• Term 100 life insurance is a bit different – if you want to find out more about it, we have a detailed publication about Term 100 life insurance policies. Just click that link to go directly to our article.
  
  Here is how it works visually:

• Whole life insurance and universal life insurance offer both an insurance protection component like term, but without time limits (the coverage is permanent). Another component allows policy holders to accumulate value (similar to relatively conservative investments), take out that value when needed, or lend money against a life insurance policy. Whole life insurance policies are typically more expensive than term. However, the premiums stay consistent through the life of the policy.
  
  Here is how it works visually:

Is Life Insurance Tax Deductible?

In the vast majority of cases, the answer to the question, “Are life insurance payments tax-deductible?” is no – life insurance premiums are NOT tax-deductible. An exception exists if a life insurance policy is used as collateral for an investment loan. In such instances, a portion of the premium may be deductible, but it’s crucial to tread carefully and seek professional advice.

Individual Life Insurance Premiums and Taxes

The life insurance premiums that a person pays to an insurance company either on a monthly or annual basis are not tax deductible. Thus, there is no need to report this to CRA (Canadian Revenue Agency) in hopes of getting the premiums credited.

Corporate-owned Life Insurance Premiums and Taxes

Corporate-owned life insurance premiums are not tax-deductible. However, if owned by a small business, corporate ownership can still be advantageous due to the difference between the small business and personal tax rates. A company gets to use lower tax dollars to pay for the life insurance premium.

Is Life Insurance Taxable in Canada (i.e. Insurance Payments/ Claim Payouts)?

If a policyholder passes away, beneficiaries will receive the FULL claim payout. Life insurance proceeds are NOT taxable in Canada when it comes to claim payouts.

For example, if a policyholder had a $1,000,000 life insurance policy, their beneficiary would receive the entire $1,000,000 without paying taxes on it.

Individual Life Insurance Payments to a Beneficiary

Proceeds from life insurance are not taxable (also called life insurance payments) and the beneficiary will receive the full benefit tax-free. Thus, CRA will not be getting a part of life insurance proceeds/claim payout.

Corporate-owned Life Insurance Payments to a Beneficiary

When the beneficiary is a corporation, much of the death benefit will be able to be a dividend paid out to Canadian resident shareholders tax-free. An exception could be if a corporately owned policy (misguidedly) names a beneficiary other than the corporation. This causes tax problems.

Are Life Insurance Cash Payouts from Whole Life Insurance Tax-Free?

If you take out cash from your whole life insurance policy, there is often a tax to pay. For this reason, it is often better to take out a collateral loan against the policy. This is similar tax-wise to a line of credit against a rental property – no sale means no gain and no taxes. Upon death, the loan gets paid off by the death benefit and the beneficiaries get the balance. Note: the lender must be a third party (not a policy loan) for this to be onside with CRA.

How Life Insurance Can Help with Tax Sheltering?

Life insurance as a tax sheltering tool is another tax-related topic and there are numerous ways to use permanent life insurance (such as whole life insurance) for tax-savings purposes. We have a detailed article on this topic – Whole Life Insurance and Taxes: Everything You Must Know.

Also, our experienced life insurance brokers are happy to explain you the details of life insurance products and associated tax impacts. Simply complete the quote request on the right side of your screen.

About the author:

Casey Cameron graduated from the University of British Columbia and has worked in financial services and insurance ever since.

He worked for six years with one of the world’s largest banks in Australia and Canada. After a stint in international banking, Casey spent a further six years with a boutique financial planning company in Vancouver, British Columbia and founded Camlife Financial in 2014.

He holds a professional financial planning designation and is a Fellow of the Canadian Securities Institute. Casey enjoys helping families, individuals and business owners with their financial planning, insurance and investment needs.