Life Insurance really is tax-free!

Updated: Mar 5, 2021

Although it may seem too good to be true, for the most part, Life Insurance in Canada is considered non-taxable. This is a huge advantage to beneficiaries who will be able to collect the full death benefit (without paying tax).

Non-taxable means that beneficiaries will not need to pay income tax on the amount they receive in the event of the policy holder’s death.

This is the case regardless of the size of the policy, partners, or anyone else named as a beneficiary. Both term and permanent Life Insurance policies are considered non-taxable insurance plans.

Since Life Insurance is non-taxable, policy holders do not need to report the interest gained on the death benefit on an annual tax return.

However, there are certain unique situations where Life Insurance is taxed:

1. No beneficiary

If the policy holder did not appoint a beneficiary to the Life Insurance policy, when the policy holder dies, their estate will automatically be the designated beneficiary. If the estate is the beneficiary, then the death benefit may be subject to tax. The best way to avoid this tax is by ensuring that a trusted beneficiary is assigned to the policy.

2. Loan collateral

Another reason taxes may need to be paid on an Insurance policy is if the Life Insurance policy has been used as collateral for a loan. This means that if the policy holder dies, the loan provider will pay off the loan using the death benefit from the Insurance policy. The policy beneficiary will have to pay taxes on any outstanding loan balance that exceeds what was paid into the policy.

3. Selling the policy

Four provinces (Quebec, New Brunswick, Nova Scotia, and Saskatchewan) in Canada allow policy holders to sell a Life Insurance policy to another person. When a policy is sold, the buyer will receive the premiums and the death benefit. The money the policy holder receives from selling the policy may be taxed. The way it is taxed will depend on the type of policy, the money paid into it, the amount received from selling it, and whether there was any cash value.

How your family can benefit from tax-free life insurance

Most of the time, the death benefit will be non-taxable which means beneficiaries can gain the full value of the death benefit. Taxes can be frustrating since they take away some of the money your family is entitled to.

The entire amount of a Life Insurance policy when paid out should be tax-free. Although, this may not be the case based on other investments (like real estate or RRSPs) where the beneficiaries would be expected to pay taxes or be taxed on the estate.

Overall, Life Insurance can help support a family’s living expenses. The money can help them maintain their quality of life and not have to worry about making ends meet. Especially if the policy holder is the financial breadwinner.

The death benefit can help a family cover the costs of a funeral. Funerals can get incredibly expensive- in Canada, the cost of a funeral can range from $5,000 to over $15,000.

The death benefit can also help a family pay off any outstanding debt. A Life Insurance policy ensures a family won’t have to bear the burden of financial hardship.

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