Taxation of Life Insurance

Photo of Life Insurance information

How is Life Insurance Taxed

Life insurance can be divided into two types: term and permanent. Term insurance has no investment component and pays out a tax-free death benefit if you die during the life of the policy. Permanent insurance, generally universal life or whole-life is designed to last throughout your life time and often has an investment component allowing you to build up cash values inside the policy in a tax-sheltered manner.

The laws regarding the taxation of life insurance in Canada are anything but straight forward and can be a complex topic; the best possible advice will come from a tax professional that can assess your own individual circumstances. The subject of taxes and life insurance are basically broken down into two main areas; the payments that are made at death, and the payments that are made during life.

When an insured person dies, the life insurance policy is settled in the form of a death benefit that is not subject to income taxes, federally or provincially. Because these proceeds are protected from income tax, life insurance is an ideal way to transfer assets to your beneficiaries.

The second area is a little more complicated in that a life insurance policy can be used as an investment tool. As a universal life or whole-life insurance can have a cash value that can potentially pay dividends or income, it has the potential to outgrow the amount paid in premiums. In those cases, the difference is considered a taxable gain. If the policyholder surrenders their coverage the money that is paid that is in excess of the policies’ ACB is taxable. The ACB is calculated as the premiums paid less the cost of the actual insurance.

It is always advisable to speak with a tax professional as they can help you evaluate the different options available to you. SolutionsFinancial.ca helps Canadians get in touch with financial advisors who can help you get the coverage you need, at the best possible price.