Life Insurance
Life Insurance Payout in Canada: What Is It and How Does it Work? (2023)
June 1, 2023
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5 minutes
Key takeaways:
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.
Anything outside of your life insurance payout could be taxed, such as 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.
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:
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.
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, such as:
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 seven days a week.
Here's when life insurance is taxable in Canada:
In short, the tax implications of a life insurance policy change depending on which type of life insurance you buy: term or permanent.
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.
Let's look in more detail when life insurance can be taxed in Canada.
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:
What’s the best way to avoid a tax payment when the executor of your estate files your final tax return?
That way your money is going exactly where you want it to go, instead of to the Canada Revenue Agency (CRA).
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.
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.
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.
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.
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.
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.
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.
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:
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 quote and application process.
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.
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:
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.
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.
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.
There are two common types of beneficiaries:
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.
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:
Whether you'll be taxed on your life insurance in Canada depends on:
Now that you have the intel to help your loved ones when they need it most, it's time to get set up with a term policy that works hard for you when it really counts.
At PolicyMe, we empower you to personalize your term life insurance policy that’s tax-free and works for your budget. And life insurance isn’t as pricey as you might think. Get a quote below and you may be surprised!
Death benefits from both term and permanent life insurance policies are not taxable in Canada, as long as a beneficiary's assigned. Any interest earnings on a permanent life insurance policy are taxable.
Employee life insurance premiums are not deductible on individual employees' income tax returns. If you're a business owner who covers the cost of employee life insurance (also often referred to as group life insurance) and the premiums are listed as a reasonable business expense, they are tax-deductible.
No, you won't be taxed if you get a loan by using your life insurance policy as collateral.
And in case you were wondering: it's true, you can use your permanent life insurance policy as loan collateral in Canada.
It's a way to access funds for your retirement or a kitchen renovation, if you need to, though experts caution against doing so.
Caveat: when you pass away the loan is paid off first and then the remaining funds go to your beneficiaries, which won't be taxed.
When you name a beneficiary, life insurance is not part of your estate, so it is not considered an inheritance. In fact, life insurance proceeds can be used to help pay for any debts associated with your estate.
Foreign life insurance policies are not treated the same as Canadian policies and often are subject to taxation. If you do own a foreign policy, ask your provider if they can provide written proof that your policy qualifies in Canada.
If it doesn’t qualify, speak to a tax specialist to clear up any cobwebs about your policy and ask for advice about reducing potential taxes for your loved ones.
For the most part, term life insurance proceeds are not taxable in Canada. This means that beneficiaries will not need to report the death benefit on their tax return, as it is not considered taxable income.
In contrast, there are scenarios in which types of life insurance policies, like whole and universal, have tax implications. A few examples of this: if the cash value of the policy has been withdrawn from by the policyholder, if there is interest earned from the policy, and if the policyholder forgets to name a beneficiary.
To be sure, it’s best to consult with an accountant to discuss any potential tax implications relating to your life insurance proceeds.
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