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

 

Do your heirs expect to inherit?

Do your heirs expect to inherit an old homestead property, a family cottage, a residence, your farm, an art collection, furniture, or business shares? They may have to be liquidated by the estate, perhaps at a loss, to pay any existing tax liability. Life insurance proceeds may help to side-step probate, or estate administration tax, and can cover any estate liabilities that could impinge on bequests that you want to make to your loved ones.

Make sure that your gifts stay in your family. Deemed dispositions of capital assets at death occur even if an asset is willed directly to an heir. A capital gains tax liability remains in the deceased’s final tax return and reduces the value of the estate.

5 Methods to reduce taxes that will be due upon your death.

  1. Use the spousal (and disabled child) rollover provisions of RRSPs or RRIFs.
  2. Leave assets that have accrued capital gains to your spouse to defer tax.
  3. Leave assets without capital gains to other (non-spouse) family members.
  4. While you are alive, gradually sell assets having capital gains, to avoid dealing with the capital gains all at once in your estate.
  5. Purchase life insurance to cover capital gains taxation in the estate.

Taxes may be payable on gains.

Income-producing real estate, a second residence, or cottage, and any other assets left to surviving family members, such as shares of a business, of stocks and investment funds may face capital gains taxation.

You may also want to consider charitable donations to lessen taxes in the estate. Hire an estate planning lawyer and make sure your Will is updated and includes your estate planning directives.

TFSAs can help transfer money to your heirs. 

Money accumulated in a TFSA does not attract taxes at the time of death. If you want to create increased transferable after-tax wealth, consider moving money into TFSAs from non-registered investment accounts. Note: It is important to get an Advisor’s guidance, and perhaps an accountant to implement this in a careful tax plan.

Be careful, though to also consider taxable implications when considering selling non-registered assets. Ask your tax advisor if you will be triggering a  taxable gain? Possibly utilize TFSAs to their maximum potential, and monitor the comparative tax impact of transferring wealth from RRSPs/RRIFs to heirs of the estate.

How do you deal with RRSP transfers upon death?

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When RRSP assets are present in an estate, there are a few steps to follow to assist transferal in the event of inheritance, death or separation.

A surviving spouse can transfer the full amount of a spouse’s RRSP as a refund of premium by rolling it into his or her RRSP or RRIF, life annuity or term annuity depending on age. Preferably, name your spouse as the beneficiary under all RRSP plans when you set them up, or make this provision in your will. Note: Your advisor will be able to look at your situation and advise you.

If you leave no surviving spouse but there is an adult child or grandchild who is ‘financially dependent’ upon the deceased at the time of death, the full RRSP can be transferred tax-free to the child’s RRSP or used to buy an annuity or RRIF. Minors, however, must use the funds to purchase an annuity with payments to age 18. Note: Your advisor should be consulted to determine if an individual is ‘financially dependent’.

In most cases outside of financial dependency, the funds are taxed in the hands of the deceased on his or her last tax return. Life insurance strategies can offset the large tax liabilities associated with RRSP/RRIF assets that seniors will face, thus increasing inheritances.

 

Parents: Do not make this mistake in your will

How does the Guardian Clause in your will protect children?

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Caring for your priceless assets – your children.

Very few Canadians have a will, fewer have a currently updated will. Without a will, you cannot outline directives regarding your most priceless asset – your children. A will allow you to clarify your selection of a legal guardian for your children. Here are some steps to take in preparing for the transfer of parental responsibility while planning your will with your lawyer.

Choose an individual to be the guardian

  • Perhaps your parents, a brother, a sister, or a friend could assume the appropriate parental role in your absence. Consider living quarters, age, health, their ethics, financial means, and their current family stress load. Talk to them and get their approval first. Do not simply assume your parents or siblings will take the children.
  • Select a contingent guardian in case the first choice denies the guardianship, takes ill, or dies.
  • Ensure that the guardian will have sufficient capital to provide for the children, which may include the need for life insurance. Know your current financial net worth and how much income it can generate for your children.

The guardian clause is only an interim appointment.

In your will, you can insert a provision that you are appointing someone as your child’s guardian (which most lawyers do). It is important to remember that any such appointment is only good for 90 days as it is an interim appointment only. Therefore, it allows all interested people to get before the court (which makes the final decision about who will be the guardian). Why include the guardianship clause if it is only an interim appointment? Because it is strong evidence of who the parents wanted the guardian to be, though it is not determinative. That is up to the court.

Include these parameters in your will.

  • Choose a trustee to invest and manage any money that your children may inherit
    • Consider having adequate life insurance to cover the children’s financial needs so as not to burden the new guardian.
  • Express your financial directives regarding the maintenance and education of your children, and the age when they may personally receive the balance of the inheritance.
  • Update your directives when your circumstances change, reflecting for example, changes in your net worth; a new child in the family; a deceased beneficiary or desired guardian; or special wishes regarding the transfer of certain assets to specific children.
  • Choose a competent, informed, and trustworthy executor with the patience to follow time-consuming legal detail.

What options does Buy-Sell Insurance give business owners?

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When a co-owner/partner dies, the surviving business owners usually have five options in dealing with the deceased owner’s business interest:

1.   Buy-out the heirs of the partner with Life Insurance proceeds: This is usually the most preferred option. After all, the surviving owners/partners know how to run their business. It usually makes sense to buy out the heirs who are not engaged in or lack expertise in the business and carry on business from there.

2.  Keep the heirs in the business.  This would only be advisable if the heir was actually involved in the business for some time, or has skills that can advance the cause and profitability of the business.

3.  Take on an outsider who purchases the deceased’s business interest. A good buy-sell agreement can circumvent the need to have an outsider buy into your business if that arrangement would harm the current business partnership or the business. In some cases an outsider may already have an investment in, have expertise in, or a common business goal with your company that would mutually benefit everyone in the business. In this case, advance planning could allow such an individual to be part of buying side of the buy-sell agreement. The same individual may need to be a beneficiary on the insured lives of all the partners, in tandem with being written into the agreement.

4.  Selling to the heirs may be an option. This may be an option when some of the heirs are involved and successful in the same line of business with primary senior family members of the earlier generation who began your business. In this case the considered heirs, should receive funding from the proceeds of a well-planned fund to cover capital gains taxes, and fund operations, and pay for the owners shares.

5.  Liquidate the business or sell it to a third party. If this is the main goal, it is wise to involve discussions with the potential buyer long before one dies. If the business is large you may need to hire a firm that specializes in valuing and selling businesses. It is wise to estimate your capital gains exposure and cover any tax liabilities, as well as redeem business debts with the proceeds of life insurance which can be paid out tax-free.

In most cases, option #1 offers the business owners the best choice, with a small expenditure to buy life insurance that makes a payment to heirs with the use of a buy-sell agreement.

Should every adult have a Living Will?

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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. 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.

Consider the following:

  • The same person may not be able to make both financial and health care-related decisions.
  • Decide what medical treatments and care are acceptable and for how long.
  • 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 affordable? Do you own Long-Term Care (LTC) or Critical Illness insurance?

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 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.

 

 

How can I reduce Probate or Estate Administration fees?

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After the death of an individual, every estate must file a final (or ‘terminal’) tax return. All assets are deemed to disposed of at the time of passing, and this can trigger probate fees and other expenses.

A certificate of appointment (“Probate”) or Estate Administration Tax (EAT) is not always necessary to actualize the transfer of certain assets. Much depends on how the asset is held during one’s lifetime, and the value of the asset transferred.  Some institutions will not require probate for assets under a certain amount.  Concerning jointly-owned real property, and bank or investment accounts, these assets will pass to the surviving joint tenant by right of survivorship.  In cases where joint ownership of assets is considered for estate planning purposes, it would be prudent to obtain legal advice.

Life Insurers offer life insurance policies, segregated funds, and term funds, which may designate one or more primary beneficiaries, and further contingent (secondary) beneficiaries, allowing probate/EAT to be circumvented entirely, enabling direct access to those funds without joint ownership or survivorship of a joint tenant. Segregated funds and term funds are classified as deferred annuity policies, and as such, these assets can help lessen the overall fees charged on your estate. Monies pass privately and directly to your beneficiaries, outside of your estate and the probate process.

Concerns for Estate Planning

In Ontario, Probate fees were the forerunner of the new Estate Administration Tax (EAT), which is to shift to the Minister of Revenue. An Executor/Trustee will now have to file a detailed summary of assets that are distributable under the will. The Ministry reserves the right to take up to 4 years to assess, or the right to reassess, making the Executor/Trustees responsible for that reassessment.  Executors and beneficiaries may face liabilities if estate assets distribute before assessment or reassessment.  How does an Executor reclaim assets already distributed?

Assessment powers are not minor With the introduction of the estate administration tax (EAT), the government has given the Minister of Revenue audit and verification powers patterned after the federal Income Tax Act, thus giving the Minister of Revenue the right to assess an estate in respect of its EAT liability.

Estate trustees may be personally liable for the claims of creditors that cannot be paid as a result of an improper estate distribution. It will be an offence for an estate trustee to fail to make the required filing with the Minister of Revenue or where anyone makes, or assists in making, a false or misleading or omitted fact in connection with the estate trustee’s filing. Because offences are punishable by fine, imprisonment or by both, errors and omission insurance may be needed by executors handling larger estates.

Potential Legal Issues for Estate Trustees and Executors
Imagine if you are a personally chosen friend of a deceased person with $1.5 million in assets, who previously selected you as Executor/Trustee of his or her estate. Though duty-bound, you may feel that the risk is now very high if an error occurs. Consequently, you may want to off-load the potential liability to a professional accountant and lawyer to present all the documentation for EAT.

Consider that the costs of such a transfer of liability could rise to the maximum of 6% per professional (two professionals would mean 2 x 6%) of the value of the Estate. This could bring the total cost of dealing with EAT to a maximum of 13.5% of the estate value. In the above case, fees could cost upwards of $202,500.

Segregated and Term funds may offer investors an edge over other investment products in the province of Ontario when it comes to planning someone’s Estate. Segregated and Term funds also offer estate privacy of the distribution of money under the insurance act.

Note: Not applicable in Québec as notarial wills do not need to be probated by the court and, for holograph wills and wills made in the presence of witnesses, probate fees are minimal.

 

Estate planning with the right insurance protection

A proper estate plan will include an updated Will and a plan to avoid paying too much tax on investment assets such as stocks, bonds, and mutual funds; and other properties that may have accrued capital gains. It will seek to minimize probate, pay off debts and prepare to meet certain family income needs. Estate planning often includes detailed life insurance planning designed to pay out a benefit upon the death of one whose estate is about to wind down.

When transferring your assets, including mutual funds, using a Will (also referred to as a Testamentary Trust), the key is to position as much of your wealth as possible to pass to your heirs. If you hold equity mutual funds that buy and hold stocks, they may have accrued capital gains. There will be a deemed disposition of all your property at fair market value at the time of your death. For some, this could mean that there may be an existing capital gains tax liability. There are a few things to assess as you begin an estate plan.

Assess your tax liability List each separate asset you own, the purchase price and date, as well as its current value. Include your non-registered investments in stocks, bonds, and mutual funds. Have your accountant assess what the tax liability will be.

Assess how you and your spouse can defer taxes Property willed to your spouse can be rolled over tax-free on your death. Your spouse will inherit the assets at the unchanged adjusted cost base (cost amount) of the property. The taxation of the asset will then occur when your spouse disposes of the property or at the death of the spouse. This tax deferral is beneficial especially if you have large holdings in equity mutual funds invested for value as in large cap or blue chip stocks. Alternatively, you can choose to transfer any asset to your spouse at fair market value on death and recognize the accrued gain or loss.

Assess RRSPs if you have dependent children RRSPs can be transferred tax-deferred to your dependent children or grandchildren, even if a spouse survives you.

Assess income splitting using a testamentary trust By establishing a testamentary trust in your will, you will be able to maintain control during your lifetime over the use of your assets such as a mutual fund investment portfolio. The trust can provide guidelines for the treatment of these assets after your death. The trust document can specify the split of income among heirs. Carefully planned income splitting may allow for significant tax savings.

Assess insurance solutions There are estate planning solutions that only insurance can offer, providing both personal and business solutions to ensure you have financial security. First, assess your tax liabilities with an estate lawyer and/or accountant and make estate plans to determine how to pay them. Consider the following various insurance plans, such as life insurance where the capital gains tax liabilities are substantial.

Personal insurance solutions to protect you and your family include:

• Life Insurance
• Critical Illness Insurance (CI)
• Long Term Care Insurance (LTC)
• Estate Preservation
• Individual Health and Dental plans

If you own a business, insurance solutions include:

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

Why is succession planning integral for business owners?

Getting into business is a lot easier than getting out. Many successful family businesses have accrued capital gains in the millions. The tax payable is so high that the business cannot afford the liability once the owner dies at least without liquidating.

One way to cover the tax liability is to save for it. The problem arises if the owner dies too soon, or the money gets used for an emergency or a new opportunity, or if the savings goal is impossible for the company to achieve.

A business owner’s retirement may depend on an estate plan.

Many business owners base their personal financial stability 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.

Find out what your tax liability will be. Despite the financial importance of their business, most 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.

Succession PlanningFrequently review your capital gains tax liability. In some cases, the payment of relatively small life insurance premiums can entirely solve the estate’s future capital gains tax problems, and/or generate capital to replace the tax that will be payable on your RRSPs when both spouses die.

When you buy life insurance it immediately covers the entire estimated liability risk, which is due. The benefit is paid upon the owner’s death (or the death of a surviving spouse).

Put succession planning on your agenda. Consider taking the time to do some succession training when you are active in the business, passing on what you know, while unifying current action with your estate plan. Sometimes successful business owners, while waiting for the perfect person to take over, run out of time.

Determine who will take over the company.  If you are a family member, an employee, or a competitor, you will need to begin negotiating with your successor(s). Income from a good succession plan may nicely increase your retirement income. Therefore, it is good to know where it will come from.

Keep your legal documents current. Revise or complete both your will and power of attorney. Review your personal and/or corporate-owned life insurance, and disability coverage.

Establish or update your buy-sell agreement. Make sure your buy-sell and key-person agreements and applicable life insurance, is current and sufficient to cover your succession plans.

Other uses of new business capital offered by life insurance. A sole owner may buy enough life insurance to add capital to offer additional financial stability where a wife, son, or daughter goes through the transition to actually run the business. Insurance can also eliminate company debt to give a succeeding son or daughter a fresh start. Finally, it can fairly equalize the division of your estate among all of your heirs.