Life Insurance
and Tax

[Complete Canadian Guide]

Life Insurance, Life Insurance Quotes, Life Insurance Advisors

Life Insurance and Tax [Complete Canadian Guide]

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 (and your business, if you own one) will be protected financially.

This protection includes:

  • Providing income replacement for your family

  • Paying off your outstanding debts

  • Insulating the business against the loss of a key person

  • Providing financial collateral on a loan

  • Funding buy-sell agreements

  • Acting as a retained earnings investment strategy

Tax consequences of your life insurance proceeds and premiums will vary depending on factors like:

  • Who owns the policy

  • Who the beneficiaries are

  • The purpose of the policy

  • The tax treatment of your specific insurance product

Life insurance and tax FAQs

Is life insurance taxable in Canada?

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.

Life insurance tax changes in 2017

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 creates 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?

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?

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.

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:

  • Registered Retirement Savings Plans (RRSP)
  • Tax Free Savings Accounts (TFSA)
  • Registered Education Savings Plans (RESP) 

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.

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.

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 (and your business, if you own one) will be protected financially.

This protection includes:

  • Providing income replacement for your family

  • Paying off your outstanding debts

  • Insulating the business against the loss of a key person

  • Providing financial collateral on a loan

  • Funding buy-sell agreements

  • Acting as a retained earnings investment strategy

Tax consequences of your life insurance proceeds and premiums will vary depending on factors like:

  • Who owns the policy

  • Who the beneficiaries are

  • The purpose of the policy

  • The tax treatment of your specific insurance product

Life insurance and tax FAQs

Is life insurance taxable in Canada?

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.

Life insurance tax changes in 2017

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 creates 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?

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?

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.

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:

  • Registered Retirement Savings Plans (RRSP)
  • Tax Free Savings Accounts (TFSA)
  • Registered Education Savings Plans (RESP) 

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.

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.

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.