Is a Life Insurance Payout Taxable?

In the event that something happens to you, a solid life insurance policy can give your loved ones some financial security by providing a death benefit that’s paid to your beneficiary or estate. The payout amount can be used to cover funeral expenses, pay off debt you leave behind, supplement income, or help provide for other needs. In most cases, the death benefit is tax free; however, occasionally, taxes are owed. Here’s what you need to know about life insurance payouts and taxation in Canada.

Key Takeaways

• A life insurance beneficiary is the person or entity who will receive your death benefit if you pass away. You can name multiple beneficiaries.
• Your beneficiaries will each receive a portion of your death benefit as a tax-free lump sum.
• If you don’t name a beneficiary, your estate will automatically become the beneficiary in the event of your death and the death benefit will be subject to estate
• There are other instances where a life insurance policy may be taxable in Canada, such as when you withdraw from the cash value of a permanent policy or you sell or cancel a permanent policy.
• If you or your beneficiaries owe tax on life insurance policy payouts, the insurance company will send out a T5 slip.

What is a life insurance beneficiary?

A life insurance beneficiary is the person, people, or entity that will “benefit” from your life insurance payout, called a “death benefit,” if you pass away. Ideally, you’ll appoint a beneficiary on your policy to simplify the settlement process after your death and eliminate extra fees and potential taxes. Your beneficiary can be a spouse, child, other family member, friend, or even a charitable organization, trust, or business. You can list multiple beneficiaries.

If you pass away and you haven’t assigned one or more beneficiaries, your estate will automatically become the beneficiary of your life insurance policy and the amount will be distributed according to the terms in your will. The death benefit will then be subject to estate taxes. Creditors can also claim it to pay off any of your outstanding debts.

Is life insurance taxable in Canada?

You may be worried that any loved ones you’ve listed as beneficiaries will be forced to report and pay taxes on the death benefit from your life insurance. Luckily, that’s not the case. Most financial gifts and inheritances, including those from a life insurance policy, are not considered taxable income in Canada. Read on for instances where this isn’t the case.

When a life insurance taxable event can occur

Certain types of permanent life insurance have a cash value that accumulates from a portion of the premiums you pay. This cash value will grow based on a set formula or may be invested so it can earn interest. Taxes are deferred on this growth while the policy is in effect unless it exceeds government limits. If you withdraw from the cash value or cancel your policy (known as “surrender”) in exchange for the cash value, you may be subject to taxes or fees (known as a “surrender charge”).

If you pass away and your beneficiaries receive a payout, the interest earned on your policy will likely be taxed as income.

If your estate is the beneficiary of your death benefit, either by default or because that’s how you chose to set up your life insurance, it will owe estate taxes on the amount. The estate itself is responsible for paying those taxes to the government, not the individual person or people listed in the will.

Here’s a summary of when a life insurance policy payout is taxable in Canada:

1. You do not name a beneficiary in your life insurance policy: In this case, your estate will become the default beneficiary and will owe estate taxes to the government on the amount of the death benefit.
2. You withdraw from the cash value of a permanent life insurance policy: The cash value of your policy is tax deferrable within certain limits while it remains in your policy. If you withdraw a portion of the cash value, you will likely owe some tax.
3. You cancel your permanent policy: If you cash out (a.k.a. surrender) a life insurance policy that was supposed to last for your entire life, some of that money may be taxable.
4. Your beneficiaries get interest earnings from your policy: In addition to the death benefit, your beneficiaries may receive interest from the cash value of your policy. If they do, it will likely be taxed as income.
5. You sell your permanent life insurance policy while you’re still alive: If your insurance provider allows policy holders to sell their policies and you live in a province, like Quebec or Saskatchewan, where it’s legal, the amount you receive in payment may be taxed as income.

Tax reporting rules for life insurance payouts

In most cases, beneficiaries who receive a life insurance payout don’t need to report it to the Canada Revenue Agency because it doesn’t count as taxable income.

However, if the policy has earned interest or dividends that do owe tax, the insurance company will send beneficiaries a T5 slip that lists the investment income they need to report to the government. Those earnings must be reported on line 12100 of that year’s tax return.

If you surrender your own policy for its cash value, you may need to report it on line 12100 of your own income tax filing. Your insurance company will send you a T5 slip if that’s the case.

How to make life insurance easy for your beneficiaries

With a little planning, you can make things simpler for your beneficiaries. Here’s what you need to do:

1. Name your beneficiaries in your policy so the death benefit doesn’t get directed to your estate. It could also speed up the settlement process if you pass away.
2. Keep your beneficiaries in the loop. They should know that they’ve been named.
3. Keep a written record of your policy and track any updates.
4. Name your secondary or contingent beneficiaries, too, in case any of your primary beneficiaries pass away before you. That way, the death benefit will remain tax free.
5. If you experience any major life changes, including marriage or divorce, the birth of a child, the loss of a loved one, retirement, change of health, the purchase of a new home, or the launch of a business, consider updating your life insurance policy.

Additional FAQs

Is the cash surrender value of life insurance taxable in Canada?

It may be. If you cancel your life insurance policy, any cash value amount you receive that exceeds the total premiums you paid is considered a taxable gain. It will be subject to your marginal tax rate on your income tax report.

Is the Canada Pension Plan death benefit taxable in Canada?

Yes. The one-time payout, which is available to the estate or beneficiary of qualifying CPP contributors, is considered taxable income.

Is life insurance tax deductible in Canada?

In most cases, life insurance premiums are not tax deductible. There are a few exceptions, like if you’re a business owner and pay premiums for your employees. No matter what your situation, make sure you chat with your RBC Insurance advisor to get clarification.

In short, life insurance shouldn’t be a complicated part of your financial plan. Speak with an RBC life insurance advisor or call us at 1-866-223-7113 if you’re in doubt about how much coverage you need or whether any portion of your policy may be taxable.

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