Life insurance proceeds are not taxable in Canada. Death benefits from life insurance policies given to named beneficiaries are received tax-free under Canadian tax laws. In 2023, Canadians received an estimated $14.7 billion in tax-exempt death benefits from life insurance policies, providing their families with the much-needed financial relief during difficult times. According to Tim Cestnick, Managing Director of Advanced Wealth Planning at Wellington-Altus Private Wealth and prominent tax columnist for The Globe and Mail, The tax-free status of life insurance death benefits is one of the greatest advantages of such policies, especially in comparison to other assets that can trigger payment of a sizeable death tax.
While the death benefit is not taxable, there are some exceptions where life insurance might be taxed.
Policy cash values grow tax-deferred with permanent life insurance, but if you redeem a policy, excess over adjusted cost basis is taxable income.
Corporate-owned policies have special tax advantages with the Capital Dividend Account, wherein it makes tax-free distributions to shareholders. Canadian private corporations in 2023 held approximately $95 billion in corporate-owned life insurance.
Policy loans are not taxable upon receipt but could trigger tax consequences when the policy matures with unpaid loans.
Participating policy dividends are exempt from tax up to adjusted cost basis.
Policy transfers between individuals can trigger taxable dispositions.
The real tax treatment depends on the type of policy, ownership structure, and payment of benefits. Term policies have minimal tax considerations beyond the tax-free death benefit. Government restrictions apply to tax-deferred accumulation in permanent insurance (whole life, universal life), and potential tax-free withdrawal of policy values under optimal design.
Canadian life insurance death benefits are not taxable. Life insurance proceeds payments to specially designed beneficiaries reach them entirely tax-free under Canadian tax provision. Canadians paid in total about $14.7 billion in death benefits tax-free from life policies in 2023, that provided badly needed financial protection for families during a time of trouble. According to Tim Cestnick, Managing Director of Advanced Wealth Planning for Wellington-Altus Private Wealth and acclaimed tax columnist for The Globe and Mail, The tax-free status of life insurance death benefits is one of the most desirable aspects of these contracts, particularly when contrasted with other assets that can be worth a lot in taxes at the time of death.
Life insurance premiums are not typically tax-deductible in Canada for individual policies. Individual life insurance premiums that individuals pay are not tax deductible on personal tax returns. In 2024, Canadians will pay around $53 billion for non-deductible life insurance premiums, and the average household will spend $2,400 per year on policy expenses. As reported by Jamie Golombek, Managing Director, Tax and Estate Planning, CIBC Private Wealth, While premium payments are not deductible in the short term, tax-free growth in permanent policies and tax-free death benefits often create significant long-term tax savings that outweigh the lack of premium deductibility.
Term life insurance has few tax implications and permanent life insurance offers considerable tax advantages. Term policies just offer a tax-free death benefit without any investment component, whereas permanent policies enjoy tax-sheltered accumulation and potential tax-free withdrawals from policy values. Permanent policies in Canada in 2024 contain approximately $340 billion of tax-sheltered cash values growing at a 5.8% average annual rate, completely sheltered from taxation on a year-by-year basis. According to Kim Moody, Director of Canadian Tax Advisory at Moodys Tax Law LLP and well-known Canadian tax specialist, The tax benefits of permanent insurance make it a key consideration in overall financial planning, particularly for individuals who have exhausted other tax-favoured savings vehicles.
Policy loans from permanent life insurance are not taxable when received. Policy loans drawn against the value of a life insurance policy have no tax effects at the moment of borrowing. In 2023, Canadians borrowed approximately $4.2 billion against the value of their life insurance policy, with a mean loan value of $78,000, all received free of immediate taxation. As stated by Mark Halpern, CEO of WEALTHinsurance.com and Certified Financial Planner, Policy loans are one of the most tax-efficient and flexible ways to access policy values over lifetime, provided policy is maintained in force and adequately funded to prevent a taxable event.
Transfers of insurance policies of life for ownership can result in taxable dispositions. Transfers of life insurance policies between persons related to each other or for consideration can result in immediate taxation if accumulation value is present under the policy. In 2023, the Canada Revenue Agency received around $225 million in additional tax from policy transfers where consideration was greater than the adjusted cost base, with an average taxable gain of $42,000. As per Wilmot George, Vice-President Tax, Retirement and Estate Planning, CI Global Asset Management, Policy transfers involve careful consideration of short-term tax effects and the long-term effect on future death benefit tax-free status, making professional tax advice a must before proceeding with any transfer.
Participating life insurance policy dividends are tax-free to a limit of adjusted cost basis. Life insurance policy dividends distributed by insurers are a return of premium for tax purposes. Participating policy dividends paid in 2023 by major Canadian insurers were 6.5% on average of policy values, with the four largest insurers distributing $5.2 billion of tax-free policy dividends to policyholders. According to Jim Ruta, insurance expert and former Investors Group Executive Manager of Life Insurance, Policy dividends are one of the most tax-effective forms of investment returns available in Canada, especially in high-tax provinces where investment income can otherwise be taxed at rates over 50%.
Whole life and universal life insurance enjoy the same tax status but differ in investment options. Universal life and whole life both enjoy tax-deferred growth, but universal policies provide more investment options and premium flexibility. In 2024, Canadian universal life policies hold approximately $125 billion in tax-sheltered investments, allocated across an average of 8.7 different investment options per policy, ranging from guaranteed interest accounts returning 4.5% to equity accounts that have averaged returns of 7.8% over the past decade. As stated by Aurèle Courcelles, IG Wealth Management’s Assistant Vice-President of Tax and Estate Planning, Universal life’s open premium rate schedule and broad array of investments make it more likely to obtain tax-favoured outcomes, but the freedom that is involved means greater responsibility for prudent policy administration to maintain exempt status.
Life insurance is highly tax advantageous for estate planning. Life insurance proceeds can offset estate taxes triggered at death and provide tax-free inheritance for life insurance policy beneficiaries. As of 2023, the average Canadian estate was subject to possible taxes of $125,000 under rules of deemed disposition, with high-net-worth estates frequently receiving tax notices exceeding $1.5 million on registered assets and capital property like real estate. As defined by John Natale, Manulife Head of Tax, Retirement and Estate Planning Services, Life insurance remains the most value-for-dollar and certain method of providing liquidity to pay tax bills incurred upon death, essentially paying those charges for pennies on the dollar versus the tax bill itself.
No, critical illness insurance benefits are not taxable in Canada if held personally. Critical illness benefit payments that are received under policies that one owns personally are completely tax-free based on current CRA interpretation. In 2023, $780 million of tax-free critical illness payments were paid to Canadians, with the average payment of $83,000, most commonly for cancer (62% of instances), heart attack (19%), and stroke (8%). As Brian Burlacoff, Principal of Brian J. Burlacoff Professional Corporation and certified financial planner specializing in insurance strategies, explains, The tax-free nature of critical illness benefits offers vital financial protection amid medical adversity, enabling recipients to concentrate on healing instead of financial stress.
Quebec tax treatment of life insurance is patterned after federal guidelines but maintains various beneficiary designation procedures. Quebec insurance policies come under the same federal tax act but are based on the Civil Code instead of Common Law. In 2023, nearly 22% of all life insurance written in Canada was sold in Quebec, with a death benefit face amount of $420 billion on an in-force basis, all subject to the same federal taxation treatment as policies written elsewhere in the provinces. According to Hélène Marquis, IG Wealth Management’s Regional Director of Tax and Estate Planning and Quebec tax expert, Although the basic tax treatment of policies is the same across Canada, Quebec’s distinct treatment of beneficiary designations, especially via wills, necessitates advanced expertise when implementing insurance planning within the province.
Corporate-owned life insurance contracts provide significant tax advantages under the Capital Dividend Account regime. Corporate death benefits create CDA credits, which allow corporate-owned life insurance firms to distribute tax-free funds to shareholders. Canadian private corporations held approximately $95 billion of corporate-owned life insurance in 2023 with an average policy death benefit of $2.1 million, creating potential CDA credits that can be distributed tax-free to shareholders. In the opinion of Hugh Neilson, Director of Taxation Services at Kingston Ross Pasnak LLP and a well-known Canadian tax expert, Corporate-owned insurance is one of the most tax-efficient ways of extracting value from a corporation, especially when combined with good CDA planning that can eliminate personal taxation on distributions.
Cash value in permanent life insurance policies builds up tax-sheltered in Canada. Investment gains in permanent policies build up tax-free from year to year on interest, dividends, or capital gains. In 2023, the average participating whole life policy returned a dividend interest rate of 6.2%, all tax-sheltered, compared to investment returns that would otherwise be taxed at marginal tax rates of up to 53.53% in provinces like Ontario. It is one of the last true tax shelters for Canadians, with no limits to contribution such as for TFSAs and RRSPs, says Peter Wouters, Director of Tax, Retirement and Estate Planning Services, Empire Life Insurance Company.
Canadian tax rules for life insurance do exist together with the Infinite Banking Concept (IBC). The Canadian tax statute does recognize permanent life insurance contracts in a manner that can be leveraged with the Infinite Banking system. The Income Tax Act does provide for tax-free growth inside the cash value segment of whole life and universal life contracts, policy loans being nontaxable events in case the policy still exists. As Nelson Nash, creator of the Infinite Banking Concept, has said, Banking is not about money, it’s about the process of how you finance everything you buy, and that process works within the Canadian regulatory framework with some variation from the American system.
Implementation does require structuring to maximize benefit while remaining within Canadian regulations. In Canada, policy loans are limited to 90% of the cash surrender value compared to 100% in the United States, and the Modified Endowment Contract regulations are replaced by the Exempt Test Policy regulations that were updated in January 2017. Statistics from the Canadian Life and Health Insurance Association show that almost 22 million Canadians owned life insurance policies worth approximately $5.1 trillion in 2022, with permanent life insurance representing approximately 37% of all in-force policies.
When developing a financial plan that includes life insurance, you should contact life insurance experts at IBC Financial. Our Experts can advise on all potential tax implications for policy owners. The owner of the policy must also consider how the tax on life insurance may affect primary beneficiaries and contingent beneficiaries. An insurer like RBC Insurance can help clarify the treatment of benefits to the beneficiaries upon settlement.
Employee benefits such as employer-provided life insurance may have different rules for taxation of life insurance. Active employees under work insurance programs may be entitled to taxable benefits for income tax purposes, particularly if the coverage exceeds specified rate limits. The percentage under which these benefits are included is for income tax purposes and may be on a tax slip box for employee taxable benefits.
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