Is Life Insurance Taxable in Canada? Experts Answer

Life insurance is usually not taxable in Canada

Life insurance death benefits are generally tax-free in Canada, and there is no death tax or estate inheritance tax that beneficiaries need to pay out.

Anything outside of your life insurance payout could be taxed, like when you withdraw money prematurely against your policy's cash value (more on that in the next section) or if there's tax due on interest earnings.

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Fact: Death benefits are non-taxable

The death benefit of a life insurance policy is paid directly to beneficiaries in one tax-exempt lump sum. This means beneficiaries don't need to report the payout as additional income on their Canadian tax return.

Is a life insurance policy’s cash value taxable in Canada?

Some permanent life insurance products, like whole life and universal life, have a cash value that you can withdraw or borrow against while you’re still alive. While it sits within your policy, your life insurance cash value is not taxable on a year-to-year basis in Canada, but it may become taxable income if you withdraw or surrender funds that exceed your Adjusted Cost Basis (ACB).

The Canada Revenue Agency (CRA) uses a value called the ACB to assess the taxable portion of your cash value when you cancel your policy or withdraw funds from it. If you withdraw or surrender funds and part of it exceeds your ACB, that amount will be taxable.

Here’s how your ACB is calculated:

ACB = total amount contributed to policy (premiums) - cost of insurance +/- any adjustments (e.g. loans, dividends, riders, or changes in insurance coverage)

For example, let’s say you’ve contributed $30,000 in premiums, and your policy’s cost of insurance was $5,000. Your ABC will be $25,000 without additional adjustments. If your cash surrender value is $30,000, your taxable amount will be $5,000, and your insurance provider will send you a T5 slip that highlights the applicable tax.

In the case of taking out a policy loan on your cash value, you can face taxes if you borrow more than your ACB or your policy lapses while the loan is outstanding.

Is life insurance tax deductible in Canada?

Life insurance premiums are generally not tax-deductible in Canada under CRA regulations. This means that you generally can't deduct the premiums paid on a life insurance policy from your taxable income.

There are some exceptions to this rule:

1. Business relations: When a life insurance policy in Canada is used for business purposes, the premiums may be tax-deductible as a business expense.
2. Loan collateral: When a life insurance policy is used as collateral for a loan, the interest paid on the loan may be tax-deductible.

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Best practices for tax and life insurance

The tax rules regarding life insurance can be complex and may depend on factors such as the type of policy, the purpose of the insurance, and the tax laws in your specific province or territory. Consult with a qualified tax professional if you have questions.

Does a beneficiary have to pay taxes on a life insurance policy?

Beneficiaries don't typically have to pay income tax on proceeds from a life insurance policy in Canada.

Since the death benefit payout is considered a financial gift, it generally isn’t considered taxable income, and it's not included in the recipient's gross income for tax purposes.

The exception is: If a beneficiary gains interest earnings on the death benefit from your policy, either through a delayed payout or by leaving it to grow in an account with the insurance provider, the interest amount will be taxed when the death benefit is paid to the beneficiary.

Not sure if this applies to you? Make sure you consult with a qualified tax professional for advice specific to your situation. Or chat with one of our licensed Canadian advisors, available Monday to Friday!

When is life insurance taxable in Canada?

The tax implications of a life insurance policy change depending on which type of life insurance you buy: term or permanent. 

• Term life insurance death benefits aren't taxable in Canada, unless your policy doesn't have a named beneficiary.
• Permanent life insurance policies, such as whole and universal, are more likely to have tax implications, like paying tax on cash value.

Here’s a comprehensive overview of when life insurance is taxable for Canadians:

1. You don't name a beneficiary in your life insurance policy.
2. You withdraw from the cash value of a permanent life insurance policy and it exceeds your adjusted cost basis.
3. Your policy lapses with an outstanding loan; the loan amount may be taxable.
4. You cancel your permanent policy (in some cases).
5. Your beneficiaries get interest earnings from your policy.
6. You sell your permanent life insurance policy while you're still alive.

1. You don't have a beneficiary

Off the bat, you should always name one or more beneficiaries when setting up your life insurance policy.

If you don't name a beneficiary in your policy, your death benefit will go to your estate as the default beneficiary, which will incur estate taxes.

Here's what happens when your estate is the beneficiary of your policy:

• If you have a will, the life insurance payout will be added to the overall assets.
• These assets will then be divided between the people listed as the beneficiaries in that will.
• The money may be taxed once the estate is settled.

The best way to avoid taxation when the executor of your estate files your final tax return is to update your life insurance beneficiaries whenever necessary (e.g. if your relationships and financial life change, or if your beneficiaries pass before you do). That way, your money is going exactly where you want it to go, instead of to the CRA. 

2. You withdraw from a permanent policy's cash value

Permanent life insurance policies can accumulate a cash value that earns interest over your policy term. Usually, this cash value is invested to increase the policy's worth.

Let's say you decide to withdraw from this cash value. The cash value of your policy will be taxable if your withdrawal affects what the policy was originally worth.

Withdrawing against your cash value, also called borrowing against life insurance, isn't a sure bet, so make sure to consult with a licensed financial professional.

3. You earn dividends on a life insurance policy

When you take out a permanent life insurance policy, you may have the option to shelter cash that is invested by your insurance provider so you can earn dividends. These dividends can remain in your policy, where they won’t incur any taxes, or they can be taken as cash or invested elsewhere.

Those dividends or earnings will be subject to tax if you cash them out or invest them outside of your policy, unless you put them in another tax-sheltered investment like a TFSA. Your insurer will send you the T5 slip including your tax amount, which you’ll report on line 12100 of your return.

4. You surrender your permanent policy

Cancelling your permanent life insurance policy, also known as surrendering your policy or cashing it out, can lead to tax implications.

Investments that live within your active life insurance policy are tax-sheltered. But when you cancel your policy, you may be taxed (as income, not capital gains) on any cash value that's built up.

5. Your beneficiaries get interest earnings

In some cases, your beneficiaries may receive interest earnings from your policy, along with your death benefit. Your death benefit will still be tax-free, but any interest gained can be taxed by the CRA as income.

The most common sources of interest build up on a death benefit are:

• Delayed payout: Delays on paying the death benefit, to which the insurance company will hold the death benefit and pay interest on it.
• Interest income option: Instead of providing an immediate payout, the insurance company gives the beneficiary the option to leave it in an account that grows with interest.

6. You sell your permanent policy

It's possible to sell a permanent life insurance policy in Canada while you're still alive, but you can only do so in Quebec.

Permanent life insurance policies are generally sold if the policyholder:

• Needs cash
• Can't afford to continue paying their premiums
• No longer wants the policy, for example.

If you do sell your permanent life insurance policy, you could get taxed on the earnings from the sale, which are considered income. You'll need to report it to the CRA.

Selling your life insurance is only legal in Quebec

It's currently illegal to sell your permanent life insurance policy in most provinces and territories in Canada. While it used to be legal in New Brunswick, Nova Scotia, and Saskatchewan until 2020, it is now only permitted in Quebec. There is a movement in Ontario to make it legal under Bill 219, which would allow Ontario residents with life insurance to sell their policies.

7. You transfer your policy

Transferring ownership of a life insurance policy can incur taxes in Canada, but it depends on who you’re transferring to.

Transfers to spouses or a qualifying trust are generally tax-free, but transferring your policy over to an individual who does not fall into either of those categories can lead to taxes. The same goes for any cash value that is transferred with the policy.

What is the tax rate for life insurance in Canada?

There isn’t a fixed tax rate for life insurance in Canada. Life insurance death benefits are generally tax-free when paid out directly to a named beneficiary. 

Taxes typically come into play when you:

• Withdraw from your policy’s cash value
• Surrender your policy
• Earn taxable dividends or interest

In these cases, the portion you gain would be taxed as income under your marginal tax rate; the same amount of tax you pay on other types of income.

Tax benefits of life insurance

In general, the biggest benefit of all life insurance policies is the tax-free lump sum payout that your beneficiaries receive if you pass away. The CRA does not tax this benefit, so your loved ones can use it however they see fit; to cover final expenses, pay off a mortgage, or replace your income. 

To top it off, here are the most noteworthy tax benefits of life insurance: 

• Cover your estate’s tax bill: When you pass, your estate, including investments or RRSPs, may incur a hefty tax bill. Your life insurance payout can be used to cover these taxes, ensuring your estate stays intact for your family and beneficiaries.
• Skip estate probate fees: Your death benefit will go directly to your named beneficiaries, which means it won’t fall into your estate and lead to probate fees.
• Tax-free inheritances: Your policy’s payout can help provide fair inheritances to your children or loved ones, and taxes won’t affect how much they receive from your death benefit. 
• Tax-deferred growth: Permanent policies build cash value, which are tax-deferred and can be withdrawn up to your adjusted cost basis without tax consequences. 

Term life insurance is the most affordable way to secure a tax-free death benefit for your loved ones. While it doesn’t include an option to build cash value, it balances the value of life insurance and provides ample protection for your family and beneficiaries during the most crucial years. 

How do I report a life insurance payout on my tax return?

You don't need to report a life insurance payout on your tax return unless you receive interest earnings on top of the death benefit. 

If a payout with interest needs to be reported, the insurance company will automatically issue a T5 slip.

If you surrender your permanent policy, your insurance provider will issue you a T5 slip, covering the taxable portion above your adjusted cost basis.

Alongside any additional T5 income, you’ll report these earnings on line 12100 of your tax return.

Can I use life insurance to reduce tax on my final tax return?

The CRA dictates your final tax amount, so you can’t technically reduce it. But life insurance can provide your beneficiaries or loved ones with a tax-free lump sum that can be used to cover your final taxes after you pass away.

To do so, you need to:

• Name your beneficiaries on your life insurance policy, so the payout doesn’t end up going to your estate (which could lead to probate fees).
• Plan with your beneficiaries to ensure part of your death benefit will be used to pay off your final taxes.

Using permanent life insurance to reduce tax isn't a good bet

Using permanent life insurance to reduce tax on your final return isn't a great strategy because:

1. You can’t actually reduce the tax on your final return. This amount is dictated by the CRA and can’t be adjusted.
2. Your life insurance payout can be used to pay your final taxes no matter what type of policy you have, and most Canadians don't need a permanent life insurance policy.

In a recent study, we found that 49 per cent of Canadians who bought life insurance through an advisor took out a permanent policy. But permanent policies typically aren’t the best choice; they're far more expensive than term policies, and if you're looking to make money from investments, it's better to max out tax-sheltered accounts like TFSAs and RRSPs first.

Term life insurance offers much higher value for the average Canadian family, as you can see from the price breakdown below.

PolicyMe offers some of the most competitive term life insurance rates in Canada, with an easy online term insurance calculator to help you assess your needs.

Is tax added to my monthly premiums?

According to the CRA, life insurance companies count as a financial institution, making life insurance premiums HST-free. This means that any policy-related transaction (e.g. underwriting, converting, or transferring) for term life and permanent life insurance policies do not include taxes. 

While you won’t have to worry about taxes when it comes to your premiums, you should still pay attention to the cost of your life insurance policy. Life insurance rates can vary from one provider to the next, so it's important to compare quotes from different providers to find a premium amount that fits your budget.

If your primary beneficiary passes away before or at the same time as you, a contingent (or secondary) beneficiary will receive your death benefit tax-free if you name them on your policy. 

Bottom line: Life insurance payouts are usually tax-free in Canada

Whether you'll be taxed on your life insurance in Canada depends on:
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• The type of policy you have (e.g. term policy versus a permanent policy with cash value)
• If you withdraw or surrender a permanent policy over your adjusted cost basis
• If the death benefit earns interest before it’s paid out to your beneficiaries
• The payment you got from selling your policy, if applicable

FAQ: life insurance and taxation in Canada