If one thinks that looking at how taxes can have an affect on life insurance is simple, they are probably wrong. There is never anything that comes about with taxes that is simple. Then added to this is the complexity that can come with life insurance buying. It can create some confusion. But, looking at taxes and life insurance on a basic level it is not all that complicated.
- 1 Is Life Insurance Taxable Income to the Beneficiary in Canada?
- 2 Is Cash Value of Life Insurance Taxable in Canada?
- 3 Do you have to Pay Taxes When Cashing in a Life Insurance Policy?
- 4 Capital Gain vs, Interest Income
- 5 Are Insurance Settlements Taxable in Canada?
- 6 Do You Have to Report Life Insurance on Your Taxes?
- 7 Life Insurance – Tax Planning
Is Life Insurance Taxable Income to the Beneficiary in Canada?
The answer to this question in most cases is no. A beneficiary will not have to pay taxes on life insurance. There can be different types of beneficiaries. Most often an insured will name one or more individuals as the beneficiaries. Then sometimes they will name a charitable organization. Other times they may want the payout of their insurance policy to go to their estate.
The estate may have financial obligations that need to get paid. The insured will use the proceeds of the life insurance policy to do this. In the majority of cases, the beneficiaries will not have to pay tax on the proceeds. That which they receive from the life insurance.
Is Cash Value of Life Insurance Taxable in Canada?
The cash value and taxes all depends on what context the cash value is being received in. It may be about the beneficiary receiving the cash value. In most cases, this is not taxable. But, if the insured is cashing out their insurance policy, it gets a little more complex. Tax can be applicable in this circumstance.
Do you have to Pay Taxes When Cashing in a Life Insurance Policy?
There are different ways one can go about cashing in their life insurance. Or enjoy some of the cash benefits from it while still alive. Some individuals on occasion will take some distributions from their life insurance. When they do, they are now setting themselves up to possibly having to pay tax on this. It is not income tax, but capital gains tax.
Calculating the capital gains can get a little confusing. For those in this situation, they may want to rely on an experienced tax preparer. Or an accountant to assist them with their taxes as they apply to this.
Calculating Capital Gains
There is a standard formula that is often used for capital gains. One that is usually simple. For example, one taxes the value of what they are getting for the item that they are paying capital gains on. Then from this, they subtract what they paid for that item. The difference is what is taxable as capital gains.
With money taken out of the life insurance, it is a little different. Some assume that you take the value of the money received. Then you deduct the cost of the insurance which was the premiums. Then tax gets paid on the difference. But it doesn’t worth quite that way.
The CRA believes that having life insurance is a privilege. And one that should be paid for. So a part of the premiums paid gets considered as a payment for that privilege.
Some individuals take money out of their life insurance policy each year. The Insurance Company will issue a T5 slip for tax purposes. This slip will show the cost of being insured. This has to get deducted from the cost of the premiums paid. Then the balance of this can get deducted from the amount of the payout of the insurance. The end figure is what will be taxable.
Capital Gain vs, Interest Income
In the case where money from the cash surrender value of the policy is being utilized, it can get complicated. It can involve having to use an adjusted cost base formula. To determine what part of the money may be taxable. Which could mean the taxes would be applicable as interest income. This would get taxed at 100% compared to the 50% capital gain cost.
Are Insurance Settlements Taxable in Canada?
Insurance can get confusing. Some individuals can mistake insurance settlements with life insurance. Insurance settlements refer to some type of agreement that an insurance company makes with an individual. For example, there could be a dispute over the payout of a life insurance policy. The life insurance Company may offer a settlement. Even though they are not paying out the full value of the insurance policy. In most cases, this would not be taxable. But, again it is complex and better handled by a professional like a tax lawyer or accountant.
Do You Have to Report Life Insurance on Your Taxes?
The Revenue Canada Agency has a list that outlines what is not taxable. On this list, it states that most amounts received from a life insurance policy. Following someone’s death is not taxable. So the beneficiary does not have to include this on their tax return.
Life Insurance – Tax Planning
There are many individuals who implement life insurance as part of their tax planning strategies. There are options to do this. It is because there are different types of life insurance policies. Some of these have investment advantages. Knowing what the tax implications are when life insurance gets used in this way is important. This is one segment where life insurance can get complex. It is important to deal with a good insurance company. One that understands what the potential tax benefits and implications are.
The government is going to keep on top of anything that can have any bearing on taxes. When it comes to life insurance and taxes rules about this, have not changed since 1982. At least not until new rules came into effect as of 2017. But, for those who are just buying simple life insurance to protect their beneficiaries, it doesn’t have to get complicated.