Is Life Insurance Taxable in Canada? Experts Answer

Life insurance is usually not taxable in Canada

Life insurance in Canada

The life insurance death benefit is generally tax-free in Canada. This is because most inheritances in Canada aren't taxable. There is no death tax or estate inheritance tax that beneficiaries need to pay out.

The death benefit is paid directly to beneficiaries in one tax-free lump sum.

Beneficiaries don't need to report the payout as additional income on their Canadian tax return.

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.

Is life insurance tax deductible in Canada?

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

There are some exceptions to this rule:

1. When a life insurance policy in Canada is used for business purposes. In this case, the premiums may be tax-deductible as a business expense.
2. When a life insurance policy is used as collateral for a loan, in which case the interest paid on the loan may be tax-deductible.

Note: 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 usually have to pay income tax in Canada on life insurance proceeds they get from a life insurance policy.

The death benefit is generally not considered taxable income, and it's not included in the recipient's gross income for tax purposes.

There are exceptions, for example:

1. If the beneficiary is also the owner of the life insurance policy, the proceeds may be subject to tax. This can happen when you own a policy and your parents are the insured and you are also the beneficiary (confusing, we know). Same for parents buying a policy on a minor.
2. If the death benefit is paid out over a period of time as a form of income, rather than as a lump sum, there may be tax implications. In Canada, though, death benefits are only paid out in lump sums.

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?

Life insurance is taxable for Canadians when...

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.
3. You cancel your permanent policy (in some cases).
4. Your beneficiaries get interest earnings from your policy.
5. You sell your permanent life insurance policy while you're still alive.

In short, 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 benefit isn'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.

Looking into term life insurance? PolicyMe offers some of the most competitive rates in Canada, plus a 10 per cent discount for couples who apply in their first year.

1. You don't have a beneficiary

When setting up your life insurance policy, you should always name a beneficiary.

If you don't name a beneficiary in your policy, your estate will be designated as the beneficiary and your death benefits may be taxed.

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

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

What’s the best way to avoid a tax payment when the executor of your estate files your final tax return? 
Whenever your relationships and financial life change, remember to update your life insurance policy's beneficiary information.
That way your money is going exactly where you want it to go, instead of to the Canada Revenue Agency (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 have a permanent policy, you may shelter cash that is invested by your insurance provider so you can earn dividends.

Those dividends or earnings are subject to capital gains tax, which you must include a T5 slip with your tax return. No worries, your insurer will send you the T5 slip, and then you report it on line 12100 of your return.

4. You surrender your permanent policy

While your life insurance policy is active, any investments within are tax-sheltered.

When you cancel your policy, though, you may be taxed on any cash value that's built up.

The cash value will be taxed as income, by the way, not capital gains.

Cancelling your permanent life insurance policy is also known as surrendering your policy or cashing it out.

5. Your beneficiaries get interest earnings

Your beneficiaries may receive interest earnings from your policy, along with your death benefit. This interest can then be taxed by the CRA as income.

Income earned as interest is usually taxable by the Canada Revenue Agency (CRA). The growth of your cash value, while it’s still locked up in your permanent life insurance policy, is exempt from taxation.

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 right now.

This is generally done if the policyholder needs cash, can't afford to continue paying their premiums or no longer wants the policy, for example.

But if you do sell your permanent life insurance policy, you could get taxed.

This is because earnings on the sale are considered income and you'll need to report it to the CRA.

Reminder: it's not legal to sell your permanent life insurance policy in most provinces and territories in Canada. There is a movement in Ontario to make it legal. If passed, the proposed Bill 219 would allow Ontario residents with life insurance to sell their policies.

It used to be legal to sell your life insurance policy in New Brunswick, Nova Scotia and Saskatchewan, but this was abolished by 2020.

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

You don't need to report a payout on your tax return unless you receive interest earnings on the death benefit, which is specific only to a permanent policy.

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

If you surrendered your permanent policy, this form would be issued to you and it will go to your beneficiary if you pass away.

Line 121 of the form will outline the interest earnings that would need to be reported, according to the Canada Revenue Agency.

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

Yes, it is possible to use life insurance to reduce tax on your final tax return in Canada. And by final tax return, we mean after you pass away.

To do so you need to:

• Name your estate as your beneficiary in your life insurance policy, instead of a person.
• Your estate isn't charged inheritance taxes by the CRA.
• The beneficiary of your estate won't have to pay taxes on it.
• You can require that your policy's death benefit is used to for any final taxes, so your estate won't have to cover them.
• Meaning your heirs won't have to use your estate to cover 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 most Canadians don't need permanent life insurance.

In a recent study, we found that 22% of Canadian parents bought permanent life insurance. 

But permanent policies aren't great because they're very expensive and if you're looking to make money from investments, it's better to max out tax-sheltered accounts like TFSAs and RRSPs first.

So why pay those sky-high permanent premiums for the rest of your life when you don’t have to?

Term life insurance is a much better 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?

Your beneficiary isn't the only one who doesn't have to pay tax for your life insurance. Your life insurance premiums are tax-free too. 

That's one of the big advantages of buying life insurance in Canada.

When you pay your monthly premiums, you won't be charged HST. That's because, like other financial services, life insurance premiums are exempt from GST/HST.

How to make life insurance easier for your beneficiaries

Losing a loved one is hard, but know that you can make claiming your life insurance easy for loved ones by taking these simple steps: 

1. Don’t forget to name your beneficiaries

Properly filing the name of your beneficiary or beneficiaries with your life insurance company can speed up the settlement process and help avoid probate, associated costs and most outstanding debts owed.

2. Let your beneficiaries know that you have them covered

Regardless of who you choose as your beneficiary, be sure to let them know. We’re sure you’ll get lots of love and gratitude in return. 

What’s even more helpful? Provide them with your insurance provider's details so they can file a death claim easily without searching through your paperwork.

3. Put everything in writing and record every detail. It’s worth the extra effort 

Be specific when it comes to how you want your policy's death benefit doled out. 

For example, if you want your children to receive your life insurance payout, list their legal names and social security numbers rather than simply listing “children.” 

If you wish to name a charitable organization as the beneficiary, outline the organization's name, address and tax ID number.

4. Name your secondary beneficiaries too. That way your death benefit will always find a tax-free home

There are two common types of beneficiaries:

• Primary
• Contingent, also referred to as secondary

A primary life insurance beneficiary is the individual who is first in line to receive your life insurance payout. Typical examples include your spouse, children or other close family members.

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. 

5. With every life change, update your life insurance too 

Common reasons to update your life insurance beneficiary include getting married, getting divorced, having a new baby or adopting a child. To amend your policy's beneficiary information, contact your life insurance agent for help.

When you fail to keep your beneficiaries up-to-date, someone other than your intended may receive your insurance payout.

PolicyMe makes it as easy as possible for your beneficiaries to claim their payout. Your beneficiaries simply need to complete the following steps:

1. Notify us by email or by completing the form of their loss
2. Complete the required claim forms and provide more documents if requested
3. Wait for our insurance partner Canadian Premier to review your claim, follow up about any additional information required and process your payment.

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

Whether you'll be taxed on your life insurance in Canada depends on:

• The type of policy you had (such as life insurance for seniors in Canada)
• The money you paid into it
• The payment you got from selling it
• And if the policy had any cash value 

FAQ: life insurance and taxation in Canada