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Is Life Insurance Taxable in Canada?

A life insurance policy is a much needed financial payout to your family upon your passing. The emotional stress of a loved one dying is hard enough to deal with; adding financial stress can put your family in serious turmoil. Designed to give peace of mind to the beneficiaries, it is good practice to understand what, if any, tax laws apply to the inheritance you leave behind. Let us look closely at the taxes applicable to your life insurance policy. 

Life Insurance And Income Tax

In Canada, life insurance is a tax-free single lump-sum payment to your family upon your death. This financial inheritance is designed to give peace of mind to those family members who have to deal with financial difficulties after your passing. Loved ones may struggle with financial circumstances such as: paying off your debts, paying for a mortgage, covering bills, and funeral expenses to name a few.   

Most importantly, your spouse, children or any other beneficiaries on your life insurance policy are tax exempt from reporting a life insurance payout as a taxable income on their Canada tax return. This does not mean that beneficiaries are completely exempt from paying taxes on a life insurance payout.

What Is Taxable On A Life Insurance Policy?

There are cases in which taxes are applied to the life insurance payout. These usually include:

  • If the estate is named as a beneficiary, then estate administration taxes and estate settlement costs like executor, legal, and accounting fees would need to be paid out in addition to any debts or taxes owed by the estate before any money or assets can be distributed to beneficiaries under the deceased’s will.

  • If your loved ones are named as beneficiaries, your taxes will be paid off from your policy first and foremost. It is important to understand that debts and taxes have to be paid off first before any money can be allocated to your loved ones. 

  • Earnings on the payout of life insurance are subject to income tax on earned interest, also dividends and realized capital gains on those invested monies.

When Do I Pay Taxes On Life Insurance?

Typically, a permanent life insurance policy may give the beneficiary an opportunity to accumulate cash value. As with any cash value investment, there is an opportunity to earn interest and growth. What is crucial here is that if you choose to receive cash value for your policy, you will pay taxes based on the amount that your investments increased in value. Also, if the beneficiaries received interest earnings from the policy, the interest would be considered as taxable income.

As you can see, life insurance inheritance can be a complicated part of your financial plan for your loved ones after your passing. At Affiliated Insurance we are committed to helping you and your beneficiaries resolve such doubts and concerns regarding a life insurance payout. Contact us today for more information.