Life Insurance and Taxes [Complete Canadian Guide 2022]

Our guide covers everything you need to know about life insurance and taxes.

10 Minute read

Originally Published: February 17, 2021

Updated: July 11, 2022

Life Insurance and Taxes [Complete Canadian Guide 2022]

Our guide covers everything you need to know about life insurance and taxes.

10 Minute read

Originally Published: February 17, 2021

Updated: July 11, 2022

Life Insurance and Taxes [Complete Canadian Guide 2022]

Life insurance is a lot like homeowner’s insurance. You hope that you’ll never have to use it, but if the unthinkable happens, you can rest assured that your loved ones will be protected financially. There are a lot of benefits to having life insurance and it is one of the best ways to secure your family’s future financial freedom. An important thing to consider for someone who has life insurance or is interested in life insurance, is taxes. This life insurance and taxes guide will answer all the questions you have about life insurance and taxes.

Possible tax consequences of life insurance

  • Who owns the policy

  • Who the beneficiaries are

  • The purpose of the policy

  • The tax treatment of your specific insurance product

Life insurance can have some tax consequences in some unique cases. For example, if you have a whole life insurance policy which is gaining interest, that interest can be taxable if you surrender your policy and receive the cash value. If your beneficiary receives any interest earned from the policy or death benefit, then the interest would be taxable as well. Another situation where your life insurance may be subjected to taxation is if you name your estate as your beneficiary, instead a person, or if your beneficiaries pass prior to you. In this case your life insurance payout may be taxed and there might be an expensive price tag on the process of distributing the money, as there will be costs for accounting, legal fees, and executor fees.

There is a possibility that there may be some tax consequences of your life insurance, they primarily depend on these factors:

  • Who owns the policy
  • Who the beneficiaries are
  • The purpose of the policy
  • The tax treatment of your specific insurance product

This is a basic guide to knowing whether or not your life insurance might be taxable or not: 

Life insurance tax guide: is life insurance taxable

Is life insurance taxable in Canada?

In general, death benefits are tax-free in Canada because:

  • They are not subject to probate (provided there is a named beneficiary)
  • They are not part of your estate, so they stay off the public record

Although there is no death or inheritance tax in Canada, there are some considerations you should be aware of.

Personally-owned policies

With personally-owned policies that have an adult beneficiary or beneficiaries, the full face amount is paid out tax-free within a few days after the insurer receives the claimant statement and proof of death.

If the beneficiary is a child, the tax-free proceeds are held in trust until the child turns 18. A named trustee can provide the beneficiary with money if needed and invest the funds according to a court-approved plan.

If the beneficiary is a registered charity, it will receive the proceeds tax-free. In return, the charity will issue a tax receipt to your estate, potentially reducing its tax liability.

You should always appoint a beneficiary on your policy. If you decide not to, your estate will be designated automatically. This means that the proceeds will be subject to an estate administrative tax and creditors may be able to claim part or all of the death benefit for any outstanding debts.

Corporately-owned policies

The payout from corporate-owned life insurance policies is tax-free but subject to different rules and processes. They must name the corporation as the sole beneficiary and corporate-owned policies with a personal beneficiary could be subject to a taxable benefit to the shareholder and/or the insured. 

When the corporation is both owner and beneficiary, upon the death of the insured it will receive a credit to a special notional tax account called the Capital Dividend Account (CDA). 

This credit requires the calculation of the policy’s Adjusted Cost Basis (ACB), which is the aggregate premiums for all years minus cumulative net cost of pure insurance (NCPI). Over time, the ACB will eventually decline to zero but depending on policy type and age, it can take years to reach this point.

The CDA credit is calculated as follows:

CDA Credit = death benefit minus ACB

Although the corporation receives the death benefit tax-free, the ACB ultimately determines how much of the proceeds are received by the shareholder(s) in the form of a non-taxable dividend. If you die before the ACB is reduced to zero, the proceeds of the life insurance exceeding the ACB would be paid out via a non-taxable dividend through a credit to the CDA.

On January 1, 2017, the Canadian government implemented significant tax changes that impacted new life insurance policies. Perhaps the most consequential adjustment was the amendments made to the NCPI factors, such as updated mortality tables.

In general, these changes resulted in a lower NCPI, which in turn created a higher ACB for a longer period of time. As noted previously, ACB is instrumental in determining how much can be paid out tax-free.

Are life insurance premiums tax-deductible in Canada?

Clients often ask us if life insurance premiums are tax-deductible. The answer is that it depends. For the most part, premiums are not tax-deductible for individuals or corporations, but under certain circumstances, it may be possible.

Personally-paid policies

Life insurance policies that are personally paid and owned may qualify for a tax deduction if you use it for collateral on a loan. If the policy is owned by a charity, premiums qualify for a credit for the tax year in which they were paid. This is different from a personally paid and owned policy with a charity as a beneficiary- in this case, your estate would receive a tax credit when you pass.

Corporately-paid policies

Premiums on a corporately-owned policy where the corporation is the beneficiary are not tax-deductible. This includes a key man life insurance policy. 

The CRA does not provide a key man life insurance tax deduction, as the business will get the death benefit. However, as is the case with personal policies, a corporation may qualify for a tax credit if the life insurance policy is used as collateral on a business loan.

If you own a life insurance policy that’s paid by the corporation, it can qualify for a deduction if the premiums are a reasonable business expense. (For example, your company covers the premiums for your employees.) Policies owned by a charity with premiums paid from a corporation qualify for a tax deduction as well.

In general, life, health, and disability insurance premiums are not deductible for individuals or corporations. A tax professional can confirm whether your situation qualifies for an exception.

Is there sales tax on life insurance premiums in Canada?

For the most part, there is no sales tax on Canadian life insurance premiums, which means that they are not subject to either the Harmonized Sales Tax (HST) or Provincial Sales Tax (PST). 

For a while, Saskatchewan was an exception to the rule. In 2017, the province levied a sales tax on all life insurance premiums, but in February 2018, this decision was reversed retroactively to August 1, 2017.

What is the exempt test?

The exempt test determines whether the earnings associated with a permanent life insurance policy’s cash value are taxable.

The Income Tax Act does not allow policies meant primarily for investment instead of protection. For a life insurance policy to accumulate tax-sheltered growth and retain its exempt status, it must pass an annual test administered by the insurance company. 

This test confirms that the policy’s cash value is staying below the MTAR line (also known as the Maximum Tax Actuarial Reserve), which establishes the maximum cash value the policy can have without losing its exempt status.

Talk to a licensed life insurance broker today!

Best Life Insurance Quotes Canada

Life insurance as a tax shelter in Canada

Cash value life insurance policies (including universal life and whole life) have significant tax advantages.

Personally-owned policies

Permanent policies have a cash value that grows tax sheltered. As investment vehicles, they present an alternative to accounts such as:

While universal life policies let you select the underlying investment, whole life policies are a passive investment handled by the fund managers of the policy’s cash component. The account value of these policies remains tax sheltered.

Corporately-owned policies

Unlike personally-owned investment accounts, any passive income that the corporation earns is subject to a substantial tax liability. There are also no options like RRSPs and TFSAs. 

Therefore, corporately-owned permanent life insurance policies provide a unique tax shelter with key advantages. More specifically, growth inside the policy does not reduce the federal small business deduction (SBD). 

Due to recent federal tax changes, corporations earning in excess of $50,000 of investment income see their SBD completely eliminated, but the growth of assets inside corporately owned policies have no impact on it.

What are the tax consequences of cashing out life insurance? 

While permanent life insurance offers tax benefits like tax sheltered growth, there is potential tax liability when you cash out the policy’s account value (fully or partially) or surrender the policy itself.

Personally-owned policies

When you partially or fully surrender a policy, the ACB has the greatest impact on your potential tax liability. Any amount over the policy’s ACB is taxable. 

For example, the ACB of your whole life insurance policy is $25,000 and its cash value is $100,000. You could withdraw up to $25,000 tax-free but the remaining $75,000 is taxable. How much you owe will vary depending on your personal tax rate.

Corporately-owned policies

Like personal policies, any withdrawal from a corporately-owned permanent life insurance policy is subject to tax above the ACB threshold. Any tax owing would be based on appropriate corporate tax rates.

Getting life insurance loans tax-free

While in some cases you may need to fully or partially surrender a whole life or universal insurance policy, there are other ways you can access the cash value, possibly tax-free.

Option 1 – Policy loan – Personally-owned

With a policy loan provided by your insurer, you can access the life insurance cash value without impacting the growth inside the policy. However, there are consequences you should consider first.

  • You would be advancing against the cash value already built-up, which normally requires interest payments.
  • ACB is a key factor because the loan is considered an advance on your benefit. The loan would be advanced against the ACB value tax-free, but anything beyond this threshold would be considered regular income and taxed accordingly. 

For example: you have a cash value of $75,000, an ACB of $35,000, and take out a policy loan for $50,000. The first $35,000 would be received tax-free while the remaining $15,000 would be taxed as regular income. However, if you repay the loan, you would receive a tax credit for the taxable portion received as income when the loan was first advanced.

Option 1 – Policy loan – Corporately-owned

Similar to a personal loan, a policy loan is considered an advance on your benefit and any amount exceeding the ACB would be taxable to the corporation. Interest on the loan may be tax-deductible to the business, provided the proceeds are used to earn income from a business or property.

Option 2 – Collateral loan or line of credit – Personally-owned

A collateral loan or line of credit gives you the option to borrow against the cash surrender value (CSV) of your insurance policy through a third-party lender. With the policy itself pledged as collateral, you can access upwards of 90% of the CSV.

Unlike a policy loan, this cash advance is not subject to taxation. The interest owing can either be paid annually or capitalized into the loan and repaid from the life insurance proceeds when you pass away.

Option 2 – Collateral loan or line of credit – Corporately-owned

A corporately-owned collateral loan or line of credit has the same basic structure as a personally owned equivalent. The lender will use the life insurance policy as collateral and the corporation receives the proceeds of the loan tax-free.

 However, one significant additional advantage is the ability to credit an additional capital dividend account (CDA) credit. When you pass away, the corporation receives a credit to the CDA equivalent to the face amount of the policy minus the adjusted cost basis (ACB). When there is a collateral loan or line of credit against the policy it creates an additional credit equivalent to the amount of the loan, allowing additional assets to flow out of the corporation tax-free.

For example: the company owns a $5,000,000 key man universal or whole life permanent insurance policy on one of its executives. 

  • The business advances a collateral loan for $750,000, which is received tax-free by the corporation. 
  • The interest is capitalized (added to the loan balance), while the corporation uses the funds for other business purposes. 
  • When the executive passes away, the loan balance is $900,000. 

Since the collateral assignment did not affect the underlying life insurance policy, it continued to grow tax-sheltered and was worth $5,500,000 on death.

Let’s assume the ACB had been reduced to zero on death. This leaves a $5,500,000 policy to be credited to the CDA. The loan itself would need to be paid off, leaving $4,600,000 to be paid out to shareholders tax-free. Given that only $4,600,000 of the $5,500,000 credit to the CDA was used, this allows an additional $900,000 worth of assets to be paid out tax-free to shareholders, providing additional tax savings to the corporation.

When do I need to pay taxes on Life Insurance?

Although your life insurance premiums aren’t taxable, your life insurance benefits are taxable when:

  • You don’t have a beneficiary
    • If you don’t have a beneficiary, your estate will be designated as the beneficiary and your death benefits may be taxed.
  • Your policy has a cash value
    • If you want to sell a permanent policy for its cash value in return, your risk of getting taxed goes up because income earned as interest is usually taxable, and earnings on the payout of life insurance are considered income if you sell your policy.
  • Your policy is loan collateral
    • If you use your permanent life insurance policy as loan collateral (ie. securing funds to pay for retirement), the part of your death benefit used to pay that loan back may be taxable in Canada. If there’s money left after the loan amount, your beneficiary will receive the rest and won’t be taxed on the remainder.
  • You sell your policy
    • Depending on where you live, you can sell your permanent life insurance policy for cash if you no longer need it or afford it, or require cash. The money you receive from selling your policy is subject to tax, depending on the following:
      • The type of policy you had
      • The money you paid into it
      • The payment you got from selling it
      • And if the policy had any cash value

Frequently Asked Questions (FAQs) about life insurance and taxes

No, unfortunately life insurance premiums cannot be claimed on your income taxes. However, if you are a business owner, there is a possibility that you can claim the life insurance payments you make for your employees as a deduction. Alternatively, payments for specific employee group insurance policies can be deducted as a business expense. 

This depends on if you have outstanding debts remaining after you pass, as well as the policy you have. Life insurance must first be used to pay taxes and debts, but afterwards if you have an actual beneficiary rather than just having your estate as a beneficiary, then they won’t be subjected to taxes.

It really depends on your policy, and if your life insurance decides that you have to pay taxes on some of the accumulated value of your life insurance policy. If you cancel or surrender your policy, you will most likely need to pay taxes on the accumulated value amount. 

No, as long as the value remains in the policy, then it is tax-sheltered. Luckily, most Canadian life insurance policies are tax-sheltered. 

Yes, you will most likely have to pay taxes on an income earned from your life insurance, this includes interest, accumulated value, dividends and more. This can be avoided if you transfer the funds into a tax-sheltered account such as a TFSA. 

No, life insurance premiums do not require you to pay HST/GST. 

Yes, in some cases it can be claimed as a deductible because it is a business expense, this can vary depending on the policy and is more so aimed towards being a deductible for a business owner. 

No, since life insurance isn’t part of your estate it is not considered an inheritance. 

Do you have questions about life insurance and tax?

If you would like to discuss your unique tax circumstances, please contact Protect Your Wealth today. We are based out of Hamilton and support clients across Ontario with tax and insurance strategies that they can trust.

At Protect Your Wealth, we’ve been providing expert advice for all types of life insurance, and retirement and investing planning, since 2007. As your Life Insurance broker and financial planner, we work with you to create a personalized plan for your family or business that covers and meets your needs.

Contact Protect Your Wealth or call us at 1-877-654-6119 to talk to an advisor today. We’re proudly based out of Hamilton, and service clients anywhere in Ontario, including areas such as Milton, Burlington, and Oakville.

Do you have further questions about life insurance?

Check out our ‘Frequently Asked Questions’ or contact Protect Your Wealth to learn more about our insurance options.