Generally, as a beneficiary, you won’t pay taxes on a life insurance payout in Canada. However, other transactions may be taxed depending on several factors, such as interest, cash-value transactions, transfers, loans, and estate ownership.
To help you understand your situation, our content team created this guide using the federal life-insurance guide, section 148 of the Income Tax Act, CRA’s T5 guide and CRA’s interest-deductibility folio.
This guide explains taxable events, tax slips, adjusted cost basis, and the insurer figures needed for taxes or cash-value transactions.
Are Life Insurance Payouts Taxable In Canada?
The lump-sum death benefit from an individual life-insurance policy is usually not taxable income for the beneficiary. Beneficiaries can usually use the proceeds as they wish.
Withdrawals, surrenders, loans, transfers, and corporate distributions are not automatically tax-free. Interest earned after the insured’s death is not automatically tax-free.
| Event | Usual starting point | Document to request |
|---|---|---|
| Lump-sum death benefit to a named beneficiary | Generally tax-free to the beneficiary | Claim settlement statement |
| Interest added because payment was delayed or left with the insurer. | Interest may be taxable to its recipient | T5 or other slip and payment breakdown |
| Death benefit paid to the estate | The benefit generally is not taxable income, but it becomes an asset of the estate. | Estate statement and provincial probate or administration rules |
| Partial withdrawal or surrender | A policy gain may be included in the policyholder’s income. | Insurer’s ACB and taxable-policy-gain calculation |
| Direct policy loan | A disposition under section 148 can create a policy gain | Loan statement, ACB and tax calculation |
| Collateral loan from a bank | Borrowing is generally separate from a policy disposition. | Credit agreement, collateral assignment and tax advice on interest |
| Transfer of policy ownership | May be a disposition with special rules | Insurer’s transfer package and professional tax analysis |
| Corporate-owned policy | Corporate analysis is necessary for dealing with death proceeds and the capital dividend account. | Insurer tax statement and accountant’s calculation |
Life Insurance Taxes On Permanent Policy Cash Value
Cash value is not automatically tax-free.
Generally speaking, under Section 148, a disposition can cause the policyholder to recognize a policy gain to the extent that disposition proceeds exceed their policy’s adjusted cost basis immediately before the disposition.
The policy adjusted cost basis is a tax calculation that changes over time and is maintained by the insurer. It is not equal to premiums paid to date, nor is it a static percentage of cash value.
Insurance Policy Withdrawals
A partial withdrawal or partial surrender may reduce the policy’s cash value. Rules in the Act determine how much of your ACB applies to a partial surrender.
Your insurer should be contacted for the amount of the transaction that is taxable and the corresponding tax slip.
Read More: See How Life Insurance Cash Value Is Withdrawn
Insurance Policy Loans
A direct insurance policy loan isn’t necessarily tax-free.
Keep the loan and tax records your insurer provides in case you repay the loan and qualify for related deduction rules, assuming you reported the policy gain.
Remember that a direct insurance policy loan accrues interest over time and reduces the amount you receive if the policy is surrendered or paid out at death.
Read More: Review the Tax and Policy Effects of Borrowing Against Life Insurance
Insurance Policy As Collateral
A collateral loan is made by a separate lender using an insurance policy as collateral. This is not the same as a policy loan. The lender could obtain rights over the policy.
Whether interest on the loan is deductible depends on the use of the proceeds and tax rules that apply.
| Question | Direct policy loan | Collateral loan |
|---|---|---|
| Lender | Life insurer | Bank or other lender |
| Tax starting point | Can be a policy disposition | Loan itself is generally not a policy disposition |
| Approval | Policy terms and available value | Credit and collateral underwriting |
| If unpaid | Interest and balance may reduce policy proceeds | Lender may enforce security and receive repayment from proceeds |
| Before proceeding | Get ACB, projected gain and death-benefit effect | Get lending terms, assignment rights and tax advice on the use of funds. |
Is The Cash Surrender Value Of Life Insurance Taxable In Canada?
Not automatically. If you are surrendering the whole policy, you will need to include in income any disposition proceeds in excess of your policy’s adjusted cost basis.
It is difficult to approximate this amount because of policy terms and prior transactions. Your insurer should advise you of the gain to report.
Is Life Insurance Tax-Deductible?
A tax professional should review who owns the life insurance policy, who the beneficiary is, how the borrowed money is used, and other provisions of the tax code.
In general, premiums paid on life insurance are not tax-deductible. Some types of business or collateral situations may receive different treatment if they meet certain requirements. Do not deduct premiums just because your business owns the policy or the policy serves as collateral for a loan.
Read More: See When Life Insurance Premiums May Be Tax-Deductible
Reporting Life Insurance Payouts On Tax Returns
Do not report a tax-free death benefit as interest. Similarly, don’t assume that a life insurance policy dividend is ordinary income, like a corporate dividend.
Your insurer will prepare an information slip for any person who receives reportable income. Follow the information and instructions provided in the slip when completing your return. If you believe that the slip is incorrect, for example, the wrong person is named or it shows the wrong type of transaction, ask your insurer to issue a corrected information slip.
What Happens When You Don’t Name A Beneficiary?
Once the policy proceeds are payable to the estate, they become estate property and can be used to settle debts or administration costs.
Heirs don’t necessarily receive only a small amount from a policy payable to the estate. It depends on outstanding debts, administration costs, tax obligations, and which laws apply. Probate and estate-administration laws vary from one province or territory to another.
Read More: See How a Contingent Beneficiary Can Prevent a Payout Gap
Making Life Insurance Claims Easier For Your Beneficiaries
| Review | What to do |
|---|---|
| Beneficiary designation | Use the form provided by your insurer. Give full legal names and all other information that is asked for. Provide contingent beneficiaries where appropriate. |
| Minor beneficiary | Make inquiries relating to a trustee, administrator or trust. Obtain legal advice in your province. |
| Irrevocable designation | Before changing ownership or making changes to beneficiaries, check if there are requirements for consent. |
| Records | Tell your beneficiaries who your insurer is, where they can find instructions on making a claim and where you store your policy number. |
| Tax file | Keep these documents along with your policy: ACB statements, loan records, tax slips, transaction confirmations. |
When Professional Tax Advice Is Needed
- Withdrawing money from the policy, surrendering it, transferring ownership, borrowing against it or donating a permanent policy.
- When the owner, insured, or beneficiary is not the same person/entity.
- When a corporation, charity, trust, estate, or non-resident is involved.
- When the policy has a loan or collateral assignment against it, has recently been transferred, or pays dividends.