Many people prefer not to pay taxes, but the reality is that you likely have to pay taxes.
When it comes to paying taxes on life insurance, it depends.
The good news is that there are certain strategies you may use to reduce the amount of taxes you pay with your life insurance policy. Read on to learn more.
Is life insurance taxable in Canada?
Usually, the Canadian government does not tax life insurance payouts. Your assigned beneficiaries receive the entire death benefit tax-free. They are free to do with it what they wish.
However, in some cases, life insurance is taxable in Canada. The amount of tax you pay on your policy depends on a number of factors, including the type of policy you have, the value of the policy, and your personal tax situation.
Death benefits are paid directly to the beneficiaries. The money does not need to be reported as supplementary income. Tax repercussions might arise from policies that generate interest or dividend income, flow through an estate, provide a policy loan, or provide cash withdrawals.
By doing proper life insurance planning, your loved ones can live their lives with minimal tax repercussions.
When will you need to pay taxes on your life insurance?
- If you sell your policy
You may be able to sell your permanent life insurance coverage depending on where you live. This is typically done if the policyholder requires cash, is unable to continue paying payments, or no longer wants the insurance.
You can legally sell your life insurance policy to another person if you live in Saskatchewan, Quebec, New Brunswick, or Nova Scotia and use a broker or funding firm. Selling a life insurance policy in Alberta, Ontario or Manitoba is not possible. You may also be taxed on the gains from the sale of your policy.
- If you don't have any beneficiaries
When you name beneficiaries on your life insurance policy, the money bypasses your estate and goes to them tax-free. When you buy life insurance, you should always name a beneficiary. Otherwise, your estate will be named as the beneficiary, and your death benefits may be taxed. Remember to update the beneficiary information on your life insurance policy if your relationships or financial situation change.
- If your policy has a cash value
Interest income is normally taxable by the CRA. The growth of your cash value while it is locked up in your permanent life insurance policy is tax-free, but when you sell your policy, the gains on the life insurance payout are considered taxable income. If your beneficiaries receive any interest profits from your insurance in addition to your death benefit, the cash value of your policy will be taxable.
You will also be taxed on any interest or dividends that you do not reinvest back into your policy. Some people, for example, use their policy interest payments or dividends to supplement their retirement income; in this scenario, the interest payments or dividend payout would be taxed.
- If you use your policy as collateral for a loan
The cash value of a policy can be used as collateral for a loan from a financial institution like a bank. The proceeds of most loans will be received tax-free because they will be structured as lines of credit. The line of credit and any accrued interest are repaid in full using the death benefit from the life insurance policy upon the insured's death. There are no tax repercussions if the policy loan is repaid throughout your lifetime using your own funds.
When can I claim my life insurance on my tax return?
The rules for reporting life insurance premiums and payouts on tax returns differ based on how you utilize your policy and the type of policy you have.
For example, a life insurance death benefit payout is not taxable income. If you earn interest or dividends, you must report the amount on your personal tax return as income. Similarly, any income from policy withdrawals or loans must be recorded.
Can I claim my premiums on my income tax?
Individuals and corporations cannot deduct the majority of their insurance premiums. Nonetheless, a few prominent outliers exist.
If you use the money from a policy loan or a collateralized loan to run a business, your premiums may be tax deductible. This is possible whether the coverage is purchased privately or through a company. If you need help with your taxes, you should speak with a tax accountant.
Is tax added to my monthly premiums?
Your beneficiary isn't the only one who is exempt from paying taxes on your life insurance.
Life insurance premiums are also tax-free. You will not be charged HST when you pay your monthly premiums. Life insurance premiums, like other financial services, are free from GST/HST.
Anyone who wants to safeguard their loved ones in the case of their death should consider getting life insurance. In most cases, the money you get from the policy will not be taxed (ie. your loved ones receive it tax-free).
This makes life insurance an attractive option for ensuring that your family is financially secure if something were to happen to you. For additional information on taxes and life insurance, contact a Dundas Life expert today.