You have planned carefully for your family’s financial future and purchased life insurance to take care of them after you pass. This planning is critical for your peace of mind and the security of your loved ones.
But you may be wondering how taxes will affect the proceeds from your life insurance benefit. Will your designated beneficiary have to pay taxes on the amount they receive from your life insurance policy? How will this affect them and their financial future?
Read on to learn more about taxes and life insurance proceeds in Canada, then contact us at Hometown Life Insurance for more information.
Are Life Insurance Proceeds Taxable in Canada?
The quick answer is no; most life insurance proceeds are not taxable in Canada. Your beneficiaries can feel confident knowing they will not have to pay income taxes on a death benefit they may receive in the future. This is regardless of the size of the policy, whether it is a term or permanent life insurance policy, or how much money the beneficiary makes when the death benefit is distributed.
This tax-free money is a lump sum that the beneficiary can use for many purposes:
Finance Education – Many people use life insurance proceeds to pay for college or university programs, especially if the policyholder passes away during the minor years of their children. Suppose the beneficiary of the life insurance policy is a minor. In that case, a trust can be structured for the proceeds of the life insurance policy with designations for education included in the trust instructions.
Pay off Debt – Paying off debt is a common use of life insurance proceeds. Student loans, mortgages, medical debt, credit card debt, and other loans and debts can be resolved with the proceeds from life insurance.
Purchase a Home – Purchasing a home can be a smart way to utilize the proceeds from a life insurance policy – this secures the beneficiary’s future, and real estate often is a safe investment that accrues value over time. Paying off the mortgage for the family’s home is a goal for many people with their life insurance benefits.
Cover Medical Expenses – Sometimes, medical expenses can add up when paying for end-of-life costs that insurance does not cover. If this is the case, some of the proceeds from a life insurance benefit can be earmarked to pay these additional medical expenses. Hopefully, it is unnecessary, but when medical care exceeds insurance, a bill may be left for surviving family members, and the proceeds from the life insurance policy can help with these debts.
Replace Income – Many people purchase life insurance to replace their income for their family if they should die during their working years. Determining how much your family will need is something your agent can help you with – make sure to consider your spouse’s life expectancy, the children’s infancy, and their education when you talk with your agent.
When are Taxes Applicable When it Comes to Life Insurance?
There is a situation you should know about when the death benefit from a life insurance policy becomes taxable.
Estate as Beneficiary
If you name your estate as the beneficiary of your life insurance proceeds, or if the person named as your beneficiary passes away before you, the proceeds of your life insurance policy will be distributed to your estate.
Once the funds are transferred to your estate, they are subject to all the usual estate fees, taxes, and other costs that go with the settlement of the estate, including the estate administration tax. It also means the funds are subject to creditors – your family may receive much less than you intend if your life insurance proceeds become part of your estate and are subsequently used to settle your debts instead of going directly to benefit your family.
This can be avoided by naming a beneficiary for your life insurance proceeds – the beneficiary can be a spouse, child, sibling, friend, partner, or charity. More than one beneficiary is allowed to be named – you can proportionally determine how to divide the proceeds between beneficiaries, such as a 50/50 split.
You can name a contingent – or secondary – beneficiary for your life insurance proceeds, as well. This means naming an additional person or entity who will be the beneficiary should your first beneficiary die before you or at the same time as you. Naming a contingent beneficiary is a smart idea to avoid the possibility of your life insurance proceeds ending up as part of your estate. You can ask your agent for more guidance on how to do this.
Taking Cash Withdrawals
You may owe taxes on proceeds from life insurance if you borrow funds from a permanent life insurance policy that has accrued value, or you take a full or partial surrender of the policy. If this is the case, your insurance carrier will send you a T5 slip so you will know to report it.
Final Thoughts
Maximizing the potential from your investments is a smart overall strategy, and your life insurance is an important investment to consider in your financial plan. Understanding how and when life insurance proceeds are taxable is your first step in maximizing your return.
Plan and name a beneficiary and a contingent beneficiary to avoid the possibility of your life insurance proceeds being distributed to your estate, where they will be subjected to estate administration tax, fees, and creditors.
If you will be naming your minor child as beneficiary, establish a trust and someone to manage the trust until they reach the majority age. Your will can help outline this and how to divide the proceeds from your life insurance policy proportionally, should you name more than one beneficiary. Remember, you control the way your life insurance proceeds are distributed, and you can ensure your beneficiaries are not burdened by taxes on the proceeds with some advanced planning. We can help guide you to make the best decisions for your family.
How do I Learn More?
To learn more about taxes on life insurance proceeds in Canada, contact the experts at Hometown Life Insurance. Our licensed experts will be happy to answer any questions you have.
External Links:
- https://www.marketwatch.com/story/canada-household-net-worth-advances-on-record-real-estate-gain-271623419840
- https://www.fsco.gov.on.ca/en/insurance/life/pages/beneficiaries.html
- https://www.fsco.gov.on.ca/en/insurance/life/pages/glossary.html#contingent
- https://www.moneysense.ca/spend/insurance/life-insurance/life-insurance-taxes-canada/
