Back in the day, life insurance helped parents provide for their children in the event that a parent passed. As time has gone on, Canadian incomes have gone up and more people are getting the hang of life insurance.
These days, many people consider life insurance options as a way to protect their money from higher taxes. They also consider it great for helping with financial wishes later in life and during retirement.
The 2017 edition of the Canadian Life and Health Insurance Facts shared that more than 22 million Canadians have life insurance. Life insurance benefits came to $12 billion, with $6.9 billion paid as death benefits and $5.1 billion paid to living policyholders.
Life Insurance Taxes in Canada
If someone gets life insurance, will they be leaving a lump sum and taxes to their loved ones?
Generally, life insurance payouts after the death of someone are not going to be taxed. Beneficiaries who are given a lump sum don’t have to pay any kind of income tax on the policy.
The insured may ask that the beneficiary uses the money in a certain way, or they may allow them to do with the money as they wish.
Life Insurance to Reduce Taxes on Estate
Individuals who have assets or an estate don’t have to name a person as their beneficiary. In fact, they do have the choice to name their estate as the beneficiary.
This is often a smart move since the Canadian Revenue Agency (CRA) does not require the beneficiary to be a person. As a result, whoever or whatever inherits your lump sum will not have to worry about paying taxes.
What the CRA requires, is for the deceased’s living representative to file a final tax return on their behalf. By doing so, the CRA assumes that the deceased has disposed of all of their assets.
Those who have a life insurance policy can use that money to cover any leftover taxes.
Permanent Life Insurance Taxes
For the most part, life insurance premiums are non-deductible.
Life insurance death benefits are tax-free.
Permanent life insurance is long-term and lasts up to 100 years. It is fairly expensive yet offers much more potential for growth.
Premiums are higher for this kind of coverage for a number of reasons, including the fact that they fund a reserve. The reserve assists with future premium payments.
A reserve is invested by the life insurance company, and the money that grows in this bucket does so on a tax-deferred basis. The growth can be used for future premiums and mortality costs.
This is ideal since mortality costs increase as policyholder’s get older.
An exempt policy defers taxes. There are rules that decide whether a policy falls into this category, but almost all permanent policies in Canada are exempt.
Changes to Tax-Exempt Policies
The rules and regulations that decide whether a policy is exempt or not began to change in 2017. The changes added additional restrictions to the acceptable amount of accumulation within exempt policies.
Fortunately, reserves are still capable of accumulating significant amounts over time for policyholders.
Benefits of the Tax-Deferred Reserve
The reserve is a beneficial asset for policyholders. Reserve money supports future premiums as well as mortality costs.
In some cases, the cash surrender value (CSV) of the reserve can be added to the original benefit intended for beneficiaries. This increased the tax-free benefit that a beneficiary receives.
The CSV represents a sum of money, which an insurance company pays to a policyholder if their policy is voluntarily terminated. An insured event allows for this as well.
The insured takes out of the policy or borrows against as a policy loan.
Policyholders should keep in mind that attempting to withdraw the CSV before death may result in tax penalties.
The money taxes as though it was interest income at 100%, rather than capital gain at 50%.
Every policy has its rules and regulations. Staying up to date on any changes that take place is key to getting the most out of a policy.
A trusted financial advisor will look at a person’s finances and offer helpful advice as to which policy may be best.
It’s a great idea to have some goals written down. Future financial planning is just as important as the present.
For the most part, life insurance policies in Canada are tax-free, but it’s best to learn about all of the rules ahead of time before choosing a policy or making changes.