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

 

Estate Planning empowers your heirs

Estate Planning is a financial planning process that every responsible working person with dependents should accomplish, even if it is preparing a last will and testament and living will for health purposes.

Estate planning can empower your heirs in the following ways:

Plan to reduce taxes in your estate When transferring your assets, including mutual funds, using a will, try to pass as much value as possible 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 a capital gains tax liability.

By knowing your estate 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.

Your spouse and deferred taxes Property willed to your spouse can be rolled over tax-free on your death. Your spouse will actually 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.

RRSPs and your children Under the rules proposed in the 1999 Federal Budget, RRSPs can be transferred tax-deferred to your dependent children or grandchildren, even if a spouse survives you. Before the 1999 Federal Budget, a transfer of RRSP funds to dependent children or grandchildren would be taxable if there was a surviving spouse.

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 your tax liabilities with an estate lawyer and/or accountant and make estate plans to determine how to pay them. Consider the use of life insurance where the capital gains tax liabilities are substantial.