What Should I Pay Attention To In The Taxation Of Life Insurance Benefits
The most important thing to remember is that life insurance taxation will largely depend on whom you have selected as the beneficiary. Life insurance taxation is always based on legislation valid at the time of benefit payment. Therefore, you should keep in mind that the taxation of benefits may change during the validity of your life insurance.
Is This Guide For You
Use this guide if you are an employer and you provide benefits or allowances to your employees, including individuals who hold an office, for items such as:
- automobiles or other motor vehicles
- board and lodging
- group term life insurance policies
- interest-free or low-interest loans
- transit passes
- tuition fees
If you or a person working for you is not sure of the workers employment status, either one of you can request a ruling to determine the status. If you are a business owner, you can use the “Request a CPP/EI ruling” service in My Business Account. If you are an individual, you can use the Request a CPP/EI ruling service in My Account for Individuals. You can also fill out and mail Form CPT1, Request for a CPP/EI Ruling Employee or Self-Employed? to the CPP/Rulings Division at the Tax Services Office in the province or territory of your residence or place of business. See the table found on Form CPT1 for the mailing addresses. For more information on employment status, see Guide RC4110, Employee or Self-Employed?
A benefit or allowance can be paid to your employee in cash or provided to your employee in a manner other than cash .
You may have to include the value of a benefit or allowance in an employee’s income, depending on the type of benefit or allowance and the reason you give it.
This guide explains your responsibilities and shows you how to calculate the value of taxable benefits or allowances.
When There Are More Than Two Parties Involved
The main parties involved in determining if your life insurance premium is taxable are the policy owner, the beneficiary, and the insured person. Usually, the policy owner and the insured person are one and the same. If this is the case, the policy is not taxable.
However, if a third person is involved, the beneficiary on the life insurance policy may be taxed. For example, say a mother buys her daughter a life insurance policy but names the father the beneficiary. In this instance, the father would be taxed.
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Create An Emergency Fund
If youre living from paycheck to paycheck, an emergency fund could take some of the pressure off. You should have between three and six months worth of living expenses in your emergency fund to cover your cost of living if you lose your job, your car breaks down or you become ill and unable to work. In creating a sufficient emergency fund, use the adage pay yourself first. You could agree to pay a set amount into the fund each month before any other bills are paid.
Do You Give Your Employee A Benefit An Allowance Or An Expense Reimbursement
Your employee has received a benefit if you pay for or give something that is personal in nature:
- directly to your employee
- to a person who does not deal at arms length with the employee
A benefit is a good or service you give, or arrange for a third party to give, to your employee such as free use of property that you own. A benefit includes an allowance or a reimbursement of an employees personal expense.
An allowance or an advance is any periodic or lump sum amount that you pay to your employee on top of salary or wages, to help the employee pay for certain anticipated expenses without having them support the expenses. An allowance or advance is:
- usually an arbitrary amount that is predetermined without using the actual cost
- usually for a specific purpose
- used as the employee chooses, since the employee does not provide receipts
An allowance can be calculated based on distance, time or something else, such as a motor vehicle allowance using the distance driven or a meal allowance using the type and number of meals per day.
A reimbursement is an amount you pay to your employee to repay expenses they incurred while carrying out the duties of employment. The employee has to keep proper records to support the expenses and give them to you.
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Ways To Avoid Taxes On Payouts
So, you have heard about a few situations that might cause taxes to be paid on the money received from an insurer. So, what can you do to avoid these situations and keep your tax liability at zero? Here are three ways that you can avoid paying taxes and keep the correct answer to the question, Is life insurance taxed?
Are Life Insurance Contracts Subject To Inheritance Tax
On the subscribers death, the sums paid to the beneficiary of the life insurance contract do not form a civil part of the estate of the deceased. Contracts taken out for the benefit of a spouse or civil union partner, certain non-profit organizations and, under certain conditions, contracts taken out for the benefit of brothers and sisters, are exempt from any taxation.
When other beneficiaries have been designated, the rules are as follows:
- For contracts subscribed after November 20, 1991, the share of capital corresponding to premiums paid by the subscriber after his 70th birthday is subject to inheritance tax for their fraction that exceeds 30,500
- Before the age of 70, a specific flat-rate deduction after application of a reduction of 152,500 per beneficiary, applies to the sums received by the beneficiary when they correspond to premiums paid by the subscriber since the 13th. October 1998 its rate is 20% on the taxable fraction of each beneficiary, which does not exceed 700,000 and goes beyond 31.25% .
- An additional reduction of 20% applies before the reduction of 152,500 in the case of a ” life generation ” contract.
Do not hesitate to contact your notary. The latter shall give you advise on the most suitable contract, depending on the personal situation.
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Perform An Ownership Transfer
You may need to transfer ownership of your life insurance policy to avoid the proceeds becoming part of your estate. Whether or not taxes are due can depend on the policy owner at the time of death of the insured. Just be careful when performing the transfer as the IRS has very specific rules regarding ownership transfers. The transfer itself might be subject to gift tax that will be due when it comes time to file your tax return.
When You Withdraw Money From A Cash Value Life Insurance Policy
When you invest in a cash value life insurance policy, part of your premium supports your loved ones and part is invested into an account to help replace lost income. You pay into it throughout your lifetime. To access this money early, you can take out a loan or a partial withdrawal.
If you take out a loan against the cash value, you can be subjected to interest payments and your benefits may shrink over time. If you opt for a partial withdrawal, you may have to surrender the policy to use the money freely. If not, that amount will be subtracted from your final life insurance payout. You shouldnât pay taxes on life insurance cash outs that are less than what you have paid into your premium.
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When Your Beneficiary Gets A Payout In A Lump Sum
In hard times, every piece of good news helps. When your spouse or other designated beneficiary gets their payout for your life insurance, no matter how big it is, they wont owe any income taxes on it. Whew! At least thats one less worry.
Now what if you somehow forgot to specify a beneficiary in the life insurance policy? In that case, the death benefit is considered part of your estate. So, is it taxable? In most cases, no. As long as the payout doesnt push the total value of the estate above a certain limit , no estate taxes would be owed.4
Property Acquired Before 1991 Or From A Non
If you acquired property before 1991, you did not pay the GST/HST. Also, you do not generally pay the GST/HST when you acquire property from a non-registrant. As a result, you cannot claim an ITC under these circumstances. However, if you make this property available to your employee and the benefit is taxable for income tax purposes, you may still be considered to have collected the GST/HST on this benefit.
You bought a passenger vehicle from a non-registrant and made it available to your employee throughout 2021. The passenger vehicle is used more than 90% in the commercial activities of your business. You report the value of the benefit, including the GST/HST and if applicable, the PST, on the employee’s T4 slip. For GST/HST purposes, you will be considered to have collected the GST/HST on this benefit even if you could not claim an ITC on the purchase of the passenger vehicle.
Examples for remitting GST/HST on employee benefits
The following examples will help you apply the rules for remitting the GST/HST on employee benefits.
Automobile benefit See examples in the section on Automobile benefits standby charges, operating expense benefit, and reimbursements.
HST considered to have been collected on the motor vehicle benefit = $5,100 × 14/114 = $626.32
The calculation of the amount of GST/HST you are considered to have collected on the motor vehicle benefit differs from that of an amount calculated on an automobile benefit.
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You Earn Interest Income
Interest income almost never goes untaxed, and life insurance payouts are no exception. A life insurance company might pay you interest for a few different reasons. Perhaps the death benefit is not immediately payable, rather it is payable at a later date with accrued interest. Perhaps the benefit is paid as an annuity over time with interest accruing during the period based on the current interest rates. Either way, you will likely owe taxes on the interest that is earned. While the base amount will still pass tax-free, you will have to claim the interest payments and pay taxes on those appropriately.
Is Life Insurance Tax Deductible
Typically, life insurance premiums are considered a personal expense. Because of this, life insurance premiums are not tax deductible. However, there are a variety of tax benefits to having life insurance.
There are deductions if you are a business owner, and you have business-paid premiums. Also, the tax deferred cash growth of the policy is not subject to taxing through government regulation either.
This means the cash value of your life insurance plan cannot be taxed while it is growing. This allows you to collect higher interest rates and avoid money being taken out.
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Your Beneficiaries Might Have To Pay Taxes If:
- Your policy is inside of Super and your beneficiary are not defined as financially tax dependent according to the Income Tax Assessment Act 1997 this typically includes children over the age of 18.
- The Executor of your Will holds onto the death benefits after your death. Any interest earned during the holding period could also be taxable as part of your beneficiaries income.
- A third party or business hold the ownership of your life insurance policy.
Uniforms And Protective Clothing
Your employee does not receive a taxable benefit if either of the following conditions apply:
- you supply your employee with a distinctive uniform they have to wear while carrying out the employment duties
- you provide your employee with protective clothing designed to protect them from hazards associated with the employment
If you reimburse or pay an accountable advance to your employee to buy uniforms or protective clothing and require receipts to support the purchases, the reimbursement or accountable advance is not a taxable benefit if:
- the cost of the uniforms or protective clothing is reasonable
If you pay an allowance to your employee for the cost of protective clothing and did not require receipts to support the purchases, the allowance is not a taxable benefit if all of the following conditions apply:
- the employee used the allowance to buy protective clothing
- the amount of the allowance is reasonable
You may pay a laundry or dry cleaner to clean uniforms and protective clothing for your employee or you may pay a reasonable allowance to your employee . You may also reimburse the employee for these expenses when they present a receipt. If you do either of these, the amounts you pay are not taxable benefits for the employee.
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What Happens To Life Insurance Proceeds If The Beneficiary Dies
It depends. If the policy named a contingent beneficiary, then the proceeds will go to the contingent beneficiary. This is why it is extremely important to plan for this situation and name a contingent beneficiary in addition to your primary beneficiary. If there is no contingent beneficiary, then the proceeds will likely go to your estate to be distributed according to your will or the intestate succession laws of your state. Unfortunately, if the proceeds go to your estate, then you might be left with a hefty tax bill. They might no longer pass to a beneficiary tax-free, so this situation might cost you thousands of dollars.
Is Whole Life Insurance Taxable
Like a term life insurance policy, the death benefit from whole life insurance isn’t usually subject to income taxes unless you receive the payout in installments, or subject to estate taxes unless the value of the estate exceeds the estate tax threshold. But if you access the policy’s cash value, surrender your policy to the insurer, or sell it to a third party, you might have to pay income taxes.
When you buy whole life insurance, the insurance company splits your premium between a cash value account and the policy’s life insurance costs. As the cash value increases, you can choose to withdraw money or take out a loan against it. If you withdraw more than your cumulative premium payments, you have to pay income taxes on the excess. In addition, most whole life policies allow you to borrow against the cash value. If you take out a loan and the loan is still outstanding when the policy is terminated, the loan amount in excess of the cumulative premiums is subject to income taxes.
You can also sell your policy to a third party if you no longer want it. If the sales proceeds exceed your cumulative premiums, minus the portion of your premiums attributed to the cost of insurance, the excess is subject to income taxes.
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So Is Life Insurance Really Taxable
For the most part life insurance in Canada is considered non-taxable which can be appealing since your beneficiaries will be able to collect the full death benefit. By non-taxable we mean that your beneficiaries wont need to pay income tax on the amount they receive when you die.
This is the case regardless of the size of the policy, your partner, or anyone else youve named as a beneficiary. If youre choosing between term and permanent life insurance policies, dont worry both of these are considered non-taxable insurance plans.
Since life insurance is non-taxable, you do not need to report the interest gained on your death benefit on your annual tax return.
However, there are certain unique situations where life insurance is taxed.
Cashing Out Permanent Life Insurance
In some cases, you can take distributions from your life insurance before you die.
Typically, you can only take pre-death distributions from permanent life insurance policies, and you must report some of the distribution as a capital gain. To calculate capital gains, you start with the proceeds of distribution and then subtract the Adjusted Cost Base of the asset. In most cases, the ACB is the amount you paid for the asset.
Many people erroneously assume the ACB in this case is the amount you have paid for your premiums over the years. Some of your premiums are an expense directly related to the privilege of having life insurance, and as a result, they cannot be used to calculate your ACB. Instead, you need to take the amount of premiums paid minus the value of insurance to determine your ACB.
For example, imagine you have taken a $150,000 distribution from your whole life policy, and over the years, you have paid $50,000 in premiums. According to the T5 slip issued by your insurance company, $10,000 of your premiums were simply related to the cost of being insured. As a result, you subtract $10,000 from $50,000 to find your ACB of $40,000. Subtract this amount from your distribution of $150,000 to arrive at your capital gain of $140,000.
References & Resources
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What Should You Do With Life Insurance Proceeds
There is no set rule about what you should do with your life insurance proceeds. It may be tempting to go on a spending spree when you first receive the money, but putting off spending for a while and consulting with a financial advisor may be a wise choice.
Thomas D. Currey, owner of TDC Financial Services in Grand Prairie, Texas, and chair of the board of directors of the nonprofit Life Happens, warns individuals to be careful with their newly acquired windfall. The one word of caution Id have is that when anyone comes into a large sum of money, its easy to spend first and ask questions later, Currey says. Seeking counsel to help you assess what your current needs are and how to make it go as far as possible is always a good idea.
You already know the scenarios that answer the question is life insurance taxable? As for what to do with the death benefit, here are some ideas: