Life insurance can provide valuable, liquid funds to an estate or other beneficiaries, but it doesn’t make the rest of the estate tax-free.
Our editorial team researched the Financial Consumer Agency of Canada’s life insurance and beneficiary guide, the Canada Revenue Agency’s current explanation of capital property at death, section 148 of the federal Income Tax Act, and FSRA’s consumer guidance before buying life insurance.
Can Life Insurance Be Used as a Wealth Transfer Tool?
If you know you’ll need liquidity upon death, permanent life insurance can help. However, a death benefit does not wipe away estate administration costs, taxes or debts.
The death benefit can help cover taxes arising at death, support any dependants you leave behind, leave a balanced inheritance to your heirs or leave a donation to charity. However, you must keep up with payments and consider if it’s worth paying premiums on the policy for decades rather than finding another way to save the amount of money needed.
How Can I Use Life Insurance for Estate Planning?
Replace Lost Income
A benefit can replace income. Determine the amount of income needed by the dependants (spouse, child or other) and the number of years that income would be needed. Next, subtract all reliable resources, including savings, insurance in force and the survivor’s future income.
Provide Liquidity for Estate Costs and Obligations
The CRA considers capital property owned by the deceased to have been disposed of at fair market value at death, unless qualifying property is transferred to the deceased’s spouse or common-law partner.
Proceeds from the insurance can help pay any resulting tax; however, they will not reduce the amount of tax owing. The executor and their tax adviser must determine the actual tax owing.
Cover Final Expenses
Also determine who will receive the proceeds and whether that person must fund the estate’s expenses. A small amount of insurance can cover funeral and administration costs. This is particularly important if the estate contains many valuable but illiquid assets.
Pay a Named Beneficiary Outside the Estate Where Allowed
There are many exceptions. Provincial legislation, missing or invalid designations, competing claims, special rights of an irrevocable beneficiary and required claims information may all affect the process and outcome.
Although it is common for the named beneficiary to receive the proceeds outside the estate, this does not guarantee the outcome. Proceeds payable to an estate form part of the estate. It also does not guarantee how long it will take to receive death benefits or that they will be received without going to court.
Read More: Explore Whole Life Insurance Options
Tax Rules to Review Before Using Life Insurance for Estate Planning
According to FCAC, the death benefit is one payment that is not taxable. Similarly, according to the CRA, most life insurance proceeds received because of someone’s death do not have to be reported and taxed. However, the exemption does not necessarily apply to all aspects of the deceased’s estate, which may include other taxable income and capital gains, so a final return for the deceased and return(s) for any estate(s) may still be necessary.
By contrast, the cash value of life insurance policies is not like a tax-exempt chequing account. Cash surrender, withdrawals, loans or a transfer of ownership while alive can incur taxes and negatively affect the overall value of the policy. Before taking any action, ask for your policy’s current loan amount, cash surrender value, adjusted cost basis (ACB) and in-force illustration.
| Planning choice | Possible benefit | Question that must be resolved |
|---|---|---|
| Name an individual beneficiary | Direct claim path outside the estate in many cases | Are there limitations on changes depending on which province’s law applies, what designation you’ve made or whether there is an irrevocable beneficiary? |
| Name the estate | The executor has cash available to pay any of the estate’s debts. | Will the proceeds face estate administration, creditor claims or provincial probate charges? |
| Own permanent insurance | As long as it’s kept active, your coverage can last a lifetime. | How sustainable is the premium? What’s guaranteed, and what’s illustrated? |
| Use a trust or corporation | May fit particular control, business or beneficiary requirements. | What legal, tax, accounting and ownership consequences apply? |
Read More: Read Whether Life Insurance Is Taxable in Canada
How to Use Cascading Life Insurance for Wealth Transfer
Cascading life insurance refers to a situation where the older generation owns a permanent life insurance policy on the life of a child or grandchild, with the idea that ownership will be transferred at a later date. Depending on each person’s role, affordability, consent, control and tax rules, the result can vary widely. Review cascading life insurance with qualified advisers.
These are a few things you need to consider before buying cascading life insurance.
a) What is the purpose of the policy? Is it for risk management, a future ownership transfer, funding another benefit or some combination?
b) Confirm the roles, such as policyowner, life insured, payer of premiums, beneficiary and contingent owner, as each role can have specific control and tax implications.
c) Stress test the policy. How long would premiums be paid? Can you access the value? What happens if you don’t pay premiums?
Read More: See How Contingent Life Insurance Beneficiaries Work
