Understanding your life insurance policy is important especially when it comes to financial effects for beneficiaries.
Buying life insurance can help give you and your family peace of mind if something were to happen to you. Your policy’s death benefit, which is the amount paid to your estate or beneficiary when you die, can be used to cover final expenses, pay off any debt you leave behind, manage everyday expenses or meet other needs. But you may be wondering, will my beneficiary have to pay taxes on the money my life insurance policy has left them? Here’s what you need to know.
Is Life Insurance Taxable in Canada?
Most amounts received from a life insurance policy are not subject to income tax. Regardless of the size of the policy, your spouse, child or anyone else you’ve named as a beneficiary would not have to report life insurance proceeds as taxable income on their Canadian tax return.
In fact, most financial gifts and inheritances aren’t taxable. There is no estate inheritance tax or death tax owed by beneficiaries or heirs; the estate itself pays any tax due to the government.
It is always recommended to appoint a beneficiary on your policy, however if you choose not to, your estate will automatically be designated. If your estate is the beneficiary of your policy the death benefit may be subject to tax.
When a Life Insurance Taxable Event Can Occur
If you have a permanent life insurance policy, there may be an opportunity to accumulate cash value. This cash value is typically invested so it has an opportunity to earn interest and grow.
If you choose to surrender the policy and receive its cash value in return, you will pay taxes based on the amount that your investments increased in value. If your beneficiaries received any interest earnings from the policy, along with a death benefit, the interest would be taxable as income.
Tax Reporting Rules for Life Insurance Payouts
The Canadian Revenue Agency makes receiving life insurance proceeds simple for beneficiaries when it comes to tax reporting. Unless tax is due on interest earnings, these amounts don’t have to be reported as taxable income on a tax return.
If there are interest earnings, the insurance company will send the beneficiary a T5 slip. The interest earnings would be reported on line 121 of the beneficiary’s return (or yours, if you surrendered your policy for cash value).
Life insurance shouldn’t be a complicated part of your financial plan. If you’re in doubt about how much coverage you need or whether any portion of your policy may be taxable, speak with your advisor.
This article is intended as general information only and is not to be relied upon as constituting legal, financial or other professional advice. A professional advisor should be consulted regarding your specific situation. Information presented is believed to be factual and up-to-date but we do not guarantee its accuracy and it should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the authors as of the date of publication and are subject to change. No endorsement of any third parties or their advice, opinions, information, products or services is expressly given or implied by Royal Bank of Canada or any of its affiliates.