Is a Life Insurance benefit taxable?

The advantages of life insurance are well known: It is foundational to a sound financial plan to ensure peace of mind for your family if anything were to happen to you.

A policy’s death benefit, payable to your estate or beneficiary when you die, maintains financial stability. The family can pay final expenses, any debt such as credit cards or business debts, and cover ongoing costs.

Is the death benefit taxable?

Most of the cash received from a life insurance contract is not subject to income tax. Your beneficiaries — spouse, children, grandchildren or other beneficiary allocated will not need to report life insurance benefit proceeds on their tax return as taxable income. However, if you have assigned your estate as the beneficiary, the death benefit could be subject to tax. Moreover, fiscal gifts or inheritances generally are not taxable. 

Beneficiaries or heirs do not owe estate inheritance tax or death tax. It is the estate of the deceased that pays any such tax due to the government. If the policy owner’s estate is the policy’s beneficiary, the death benefit may — in some cases be subject to tax. 2 

When could a taxable situation arise?

When you own a permanent life insurance policy, accumulating interest or equity investments made to a policy’s cash value, taxes will be payable on that growth gained above the cost base of money invested. 3 

Upon your beneficiaries receiving any investment earnings from the policy, along with a death benefit, the increase on investments, not the death benefit, would be taxable as income.

Likewise, you will pay taxes on any increase in cash value based on the investments in the policy fund — should you surrender the policy and receive its cash value in return. 

Tax Reporting Rules for Life Insurance Payouts

The Canadian Revenue Agency (CRA) makes receiving life insurance proceeds easy for beneficiaries relative to tax reporting. Unless the tax is due on the above-stated earnings, these amounts do not need reporting as taxable income on a tax return.

What if there is an increase in the cash value? 

These amounts don’t need reporting as taxable income on a tax return unless some tax is due on interest earnings. If there are interest earnings, it will be reported to the beneficiary by the insurance company on a T5 slip, reportable on line 121 of the beneficiary’s return (or of the policy owner when surrendering the cash value of the policy).

1 Canada.ca 

2 Turbo Tax

3 Turbo Tax

4 Canda.ca

 

Living Will: Advanced Medical Directive

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The Living Will (or Advance Medical Directive) is a document in which you state your wishes regarding the continuance or refusal of extreme medical care, or just how much life support intervention you want prior to death as you age or if you become seriously ill. It comes into play only if and when you cannot make those decisions yourself. If you become incapacitated, with no possibility of recovery from mental or physical disability, would you prefer to live or die? This hard question, once answered, will determine the directives you set forth in your Living Will.

How to talk about dying An article in the New York Times by Ellen Goodman, How to Talk About Dying, looked at this question in retrospect from a child’s perspective recalling her own mother’s health decline:

Yes, my mother and I talked about everything — but we didn’t talk about how she wanted to live toward the end. The closest we ever came to discussing her wishes was when she would see someone in dire straits and say, “If I’m ever like that, pull the plug.” … Gradually and painfully, my mother lost what the doctors call “executive function,”… Eventually, she couldn’t decide what she wanted for lunch, let alone for medical care.

The same person that you are today, or you know today such as a parent, may not be able to make both financial and health care-related decisions due to a decline in health. You can decide in advance what medical treatments and care are acceptable and for how long. For example:

• If you heart stops or you stop breathing do you want to be resuscitated?
• If terminally ill, do you prefer to stay at home or be hospitalized?
• Is special care or medicine for a rare disease affordable?
• Is owning Long-Term Care (LTC) or Critical Illness insurance important to your future well-being as you age or if you become critically ill?

Everyone over age 18 should have a Living Will

Many government jurisdictions are writing new laws recognizing Living Wills. Even if not yet legally binding, a Living Will allows you to indicate your wishes providing guidelines for your family physician, family members and friends—those who would be asked to make health care decisions on your behalf.

Formulate your Living Will with a lawyer (or on your own) and discuss it with your potential decision-makers. Give each of them a copy, updated when necessary, for reference. Have at least two of them witness each copy.

The Living Will alleviates the heavy burden of a son or daughter or sibling, deciding to allow a loved one to die. By setting forth your request in advance with a clear mind, you intentionally share in that great responsibility, thus lessening any feelings of fear, guilt or indecision that these people may have to face. In the same article mentioned above, Ellen Goodman reflected on her mother’s situation in light of historic health decisions and recalled her earlier statement about what she didn’t want to endure:

In some recess of my mind, I still assumed that death came in the way we used to think of as natural. I thought that doctors were the ones who would tell us what needed to be done. I was strangely unprepared, blindsided by the cascading number of decisions that fell to me in her last years….I had to say no to one procedure and yes to another, no to the bone marrow test, yes and yes again to antibiotics. How often I wished I could hear her voice in my ear telling me what she wanted. And what she didn’t want.

Ellen’s reflections may help us think about our own reality, our own health care directives which in most cases can’t be thought out if someone is mentally incapacitated, or if an emergency health crisis ensues – then it may be too late – when the burden falls on our loved ones.

My own sister, a nurse, felt she had to make the right decisions to keep my own beloved mother alive. More than once she was faced with the frightful case of dialoguing with doctors about reviving my 81-year-old mother, who had taken a serious fall causing internal bleeding of the brain. Mother went through three years of being in several hospitals, then and Long Term Care homes. I vividly recall mom saying of a woman who sat muttering incoherently in her LTC home, in her own humorous words: “if I get like that, let me go”. I agree with Ellen Goodman’s statement:

When my mother died from heart failure and dementia, I began to talk with others. It was extraordinary. Everyone seemed to have a piercing memory of a good death or a hard death. Some of these stories had been kept below the surface for decades, and yet were as deep and vivid as if they’d just happened…Too many people we love had not died in the way they would choose. Too many survivors were left feeling depressed, guilty, uncertain whether they’d done the right thing…The difference between a good death and a hard death often seemed to hinge essentially on whether someone’s wishes were expressed and respected. Whether they’d had a conversation about how they wanted to live toward the end.

Talk to your life insurance advisor about Long Term Care, which is appropriate for your advanced medical directives. Also, talk to your lawyer about creating a Living Will to develop advanced medical directives while you are coherent and able to do so. Then let your loved ones know your wishes and give them a copy.

by Glen Jackman, Editor of Adviceon Media, copyright of Adviceon

How can Universal Life help business-related estate planning?

Universal Life strategies can help business related estate planning in these ways:

  • Protect your business assets.

If you own a business and die, will your partners be able to pay for your share of the company? Why not insure your life, and the lives of the other partners and key employees?

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The death benefit of the policy can create immediate capital to take the business through the transition of losing one of its leaders, while allowing surviving partners to buy out the outstanding interests (payout share ownership of the deceased partner, using a buy-sell agreement), pay off creditors or in the case of the key person, provide head-hunting monies to replace him or her.

  • Business owners can protect spouses.

If a spouse who was not active in your company survives, chances are he or she would rather be paid cash for the value of their shares and leave the running of the business to the surviving children or partners. It is difficult for executors to make sure that a wife, for example, is paid enough money to live on if she continues to share ownership.

In some cases, surviving spouses constantly need to be updated on the business’s finances, and performance and all too often have issues getting their due income. An insurance policy could rid the executors of the responsibility of ensuring that the company’s remaining owners pay the spouse. The insurance benefit could be paid directly to the spouse or flow through the business or the business partners as per a pre-established buy-sell agreement.

  • Who is the tax-advantaged plan designed for?

As with any life insurance policy, it is designed to pay beneficiaries a tax-free benefit upon the policy owner’s death. That is the main reason to buy such a life insurance policy.

The taxation scenario is a great secondary benefit, but the main purpose should be to ensure that needs are covered by the life insurance component.

An Estate Plan for the business and the family

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A comprehensive estate plan includes a will, a plan to minimize the capital gains liability and provide for any family income needs. This often involves life insurance which is an effective tool to maximize the size of your estate and pay any tax liability cost effectively. I will design an estate plan tailored specifically for your situation because every person is a unique individual.

We provide both personal and business insurance solutions for your financial security.

Business Insurance solutions:

• Partnership insurance
• Buy/Sell agreements
• Key Person insurance
• Business Disability insurance
• Business/Office Overhead
• Collateral Loan insurance
• Group Health Benefits

Personal Insurance solutions to protect you and your family:

• Life Insurance
• Critical Illness insurance
• Long-Term Care insurance
• Estate Preservation
• Individual Health and Dental Plans

The Buy-Sell Agreement: A financial safeguards for shareholders

 

 

 

 

 

 

The Buy-Sell agreement is one of the most important legal documents a business can have to protect shareholders in the event of the death of a business owner/partner.

They must be planned ahead Whether you own a partnership or corporation, we can help you set up a buy-sell agreement while you are alive and capable of doing so. We will help you value your company and set up the right Buy-Sell Agreement to meet Canada Revenue Agency’s (CRA’s) standards.

Funding the Agreement We can determine if the company has the cash flow or a large amount of money available to fund the buy-out of the deceased or disabled owner. If not, life insurance can be used to fund a buy-sell agreement as it can pay a large amount of tax-free capital at the right timing of the death of a business owner/partner.

Making it legally binding We can meet with your lawyer and the buyers’ lawyers. After it is drafted, all parties will review it to their satisfaction, and then sign it to make it legal. It is suggested that the life insurance be purchased first to ensure that one is insurable. Even where there is a medical problem, in most cases, there is an insurer willing to design a policy to suit the risk, based on the respective health of the individual.

Essential Estate Planning protects your financial security

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A comprehensive estate plan includes a will, a plan to minimize the capital gains liability and provide for any family income needs. This often involves life insurance which is an effective tool to maximize the size of your estate and pay any tax liability cost effectively. I will design an estate plan tailored specifically for your situation because every person is a unique individual.

Providing both personal and business insurance solutions to protect your financial security.

Business Insurance solutions:

• Partnership insurance
• Buy/Sell agreements
• Key Person insurance
• Business disability insurance
• Business/office overhead
• Collateral loan insurance
• Group health benefits

Personal Insurance solutions to protect you and your family:

• Life Insurance
• Critical Illness Insurance
• Long-term care insurance
• Estate Preservation
• Individual health and dental plans

What evidence proves that life insurance is worthwhile?

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Life insurance has unlimited tactical financial uses.

Life Insurance includes cash benefit payouts arising from personal life insurance, disability insurance, group life and group disability insurance; and income from annuity payments, which together have risen to approximately 40 billion dollars per year in the first decade of the new millennium.

For a person running a business, a disability insurance policy can replace up to 75% or more of the value of a disabled person’s normal working paycheque.

“Life insurance is the first foundation of wealth preservation.”

Personally owned individual life and/or disability insurance can:

  1. Pay off a home mortgage if the family breadwinner dies.
  2. Pay debts and taxes accrued in larger estates leaving heirs with financial stability.
  3. Help small businesses using agreements pass the baton to new leaders.
  4. Fund key-man insurance to replace a leader in a small business.
  5. Help family businesses and farms stay in the family through succession planning while passing wealth (and paying off liabilities) to the next generation.
  6. Pay off capital gains taxes on second properties such as a cottage.
  7. Cover taxes due when remaining Registered Retirement Savings Plan (RRSP) or Registered Retirement Income Fund (RRIF) holdings.
  8. Pay off large capital gains on investments at home and abroad.
  9. Equalize estates divided amongst siblings whose parents own significant business assets, where some work outside the firm.

The use of life insurance is increasingly creative the more wealth preservation becomes necessary and can assist in this important strategic area of fiscal protection. It can pass substantial sums of cash to future generations using techniques such as estate bonds.

Why is an estate plan important for retiring business owners

When a business represents the major component of an estate, planning is vital. Entrepreneurs may think about retirement planning, yet not all business owners implement plans to allow them sufficient freedom to follow their leisure dreams. If you ask the owner of a successful small business if he or she plans to retire, you may hear, “I will never retire because I love what I do”, or “I will retire in 10 years or so.”

Why is this risky planning? Those who feel they never want to retire may not have developed retirement investment interests outside of the company aside from RRSPs. However, most believe their company will provide investment capital when sold, or, if passed on to the next generation, a salary or dividend payments.

Are all your eggs in one basket? Therefore, for some, their personal financial stability is riding on the future success of the company. When a business represents the major value of an estate, planning becomes necessary. Yet, many are not convinced that they need to plan their estate or the succession of their business.

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Estate Planning is vital to Succession Planning. Despite the financial importance of their business, most business owners do not know what the tax liability would be if both spouses were to die. An estate plan can ensure that these taxes will be paid from one or a combination of the following sources:

  • Life insurance;
  • The business, from cash flow or liquid assets;
  • RRSPs (also taxed when both spouses die);
  • Non-registered investments.

Consider the following:

  • Take the time to do some basic estate planning to determine who will take over the company, and where your retirement income will come from. Revise or complete both your will and power of attorney. Review your personal and/or corporate-owned life insurance, disability coverage, critical illness insurance, long-term care insurance and key-person insurance.
  • Many business owners carry life insurance but miss a very important coverage related to health. Disability insurance and/or critical illness insurance can pay off a buy-sell agreement and provide income.
  • In some cases, the payment of relatively small life insurance premiums can entirely solve the estate’s future capital gains tax problems, or generate capital to replace the tax that will be payable on your RRSPs when both spouses die.
  • Life insurance can also eliminate company debt and help a succeeding son or daughter with new business capital. Finally, it can help fairly equalize the division of your estate among all of your heirs.