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.
Senior Couple purchasing a Tax Advantaged Permanent Life Insurance Policy
You’ve worked hard to achieve a degree of financial success and have set aside non-registered investment funds as an inheritance for an adult child or a grandchild. You don’t want the tax burden and probate fees to reduce the legacy you’ll leave behind. Although you’re unlikely to ever need the money yourself, you’re concerned about the safety of your investments and having access to the funds should your circumstances change. Also, you’re in a high marginal tax bracket and are frustrated with paying significant annual taxes on the growth of these assets.
Purchase a tax-advantaged permanent life insurance policy with your adult child as the life insured and the designated contingent owner. Your grandchild (the child of the life insured) is named as the beneficiary of the policy. By transferring your non-registered assets into the policy, you’ll reduce your future annual tax burden. Funds invested in a tax-advantaged life insurance policy allow for accumulation of cash value inside the policy (within legislative limits), and you don’t have to pay income tax on this growth. At your death, because of certain income tax provisions applying to life insurance policies, you may transfer ownership of the life insurance policy to your adult child (who is the only life insured on the policy) without your estate paying any tax on the cash value growth. The transfer is also free of probate, executor and legal fees. Upon the transfer of ownership of the policy to your adult child, he or she will have access to the cash value in the policy while he or she is living. Alternatively, your adult child can maintain the policy to be passed on at their death to your grandchild as a death benefit, again without taxes, probate or legal fees. The cash value in the policy remains completely accessible and in your control while you’re alive. Contact Solutions Financial today and they will customize your life insurance coverage and match your investment goals with your risk tolerance.
All comments related to taxation are general in nature and are based on Canadian tax legislation, which is subject to change, and apply to Canadian residents. For the implications as they relate to individual circumstances, consult the appropriate legal, accounting or tax expert.