How Your Family Can Benefit From Tax
Most of the time your death benefit will be non-taxable which means your beneficiaries can gain the full value of your death benefit. Taxes can be frustrating since they take away some of the money your family is entitled to. The entire amount of a life insurance policy when paid out should be tax-free. Although, this may not be the case based on other investments where the beneficiaries would be expected to pay taxes or be taxed on the estate.
Overall, life insurance can help support your familys living expenses. The money can help them maintain their quality of life and not have to worry about making ends meet. Especially if you are the financial breadwinner, consider how your loss of income would affect your family.
The death benefit can help your family cover the costs of your funeral. Funerals can get incredibly expensive, dont let your family foot the bill. In Canada, the cost of a funeral can range from $5,000 to over $15,000.
The death benefit can also help your family pay off any outstanding debt. Tie up your financial loose ends, so your family wont have to bear the burden.
Should Clients Cash Out An Insurance Policy
Clients who need access to cash will come to you for solutions
- May 6, 2016September 10, 2018
Clients who need access to cash will come to you for solutions.
If they have permanent life insurance, one option is cashing out the policy. But while it wont affect future insurability, theres a tax hit if a client surrenders his policy prior to death. Thats because permanent insurance policies have an investment component thats tax-sheltered. Pulling out cash early means the client will have to pay tax on that income.
Elli Schochet, an associate at Al G. Brown & Associates in Toronto, says the amount of tax clients have to pay depends on the ACB of the policy.
The ACB is determined through a complex CRA calculation, but in short, its made of the premiums put into the policy, less the net cost of pure insurance.
If the ACB is $20,000, and theres $100,000 built up in a policy, the client would pay tax on the remaining $80,000 .
And how long a client has had a policy makes a difference. The best time to cancel and have the lowest tax impact is probably within the first few years, says Schochet. The longer the policy has been in place, the higher the percentage of the cash value thats taxable.
While the tax impact may be lower early on, Ashley Rodrigues, director, Insurance Solutions at BMO Insurance in Toronto, says it usually isnt appropriate to cash out over the short term .
Here are a few alternatives for cash-strapped clients with permanent life policies.
Is The Cash Value Of Your Life Insurance Policy Taxable
Yes and no. As far as your beneficiaries are concerned, most life insurance policies are considered non-taxable. That means that, if you have a permanent or term insurance policy in place when you pass away, the money your beneficiary will receive does not need to be reported on their tax return. This regulation, however, does not apply if you decide to cash in your permanent life insurance policy early. In that case, the cash surrender value of your life insurance policy is considered taxable you will have to pay tax based on the increased value of your investment however, the value of the investment is not taxed until it is cashed in, so it is considered a tax-free investment and savings opportunity, as long as it is accumulating value.
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SUBJECT: INCOME TAX ACT Policyholders Income from Life Insurance Policies
REFERENCE: Section 12.2 , 20, and 148, , , , and , and the definitions of “life insurance policy” in subsection 138, and “adjusted cost basis” and “disposition” in subsection 148 and paragraphs 56 and of the Income Tax Act and sections 304 to 307 subsections 201, 217, 308, 309 and , and the definitions of “net cost of pure insurance” in subsection 308 and “modified net premiums” in subsection 1404 and paragraphs 1401 and of the Income Tax Regulations)
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This bulletin cancels and replaces Interpretation Bulletin IT-87R dated February 28, 1986.
This bulletin deals with the treatment of policyholders’ income from certain life insurance policies and annuity contracts. It outlines the basis on which various types of taxpayers must report accrued investment income for policies last acquired before or after certain relevant dates. With some exceptions , a taxpayer must report the accrued investment income on a life insurance policy or an annuity on an annual basis. However, if the policy or annuity was last acquired before 1990 and the policyholder is an individual, the accrued investment income must generally be reported every three years, unless the individual has elected to report the income on an annual basis.
Withdrawing Money Beyond The Basis
Emanuel decides instead that he need to withdraw $200,000 from the policy.
Doing this, Emanuel will owe taxes on $50,000. He owes no taxes on $150,000 of the withdrawal because that is his cost basis in the policy. The $50,000 remaining is part of the gain he achieved with the policy and he’ll owe ordinary income taxes on this sum.
Any amount withdrawn above the cost basis of a life insurance policy is taxable as ordinary income. If Emanuel canceled the entire policy, he’d receive $500,000 in cash from the life insurance company. He would also owe taxes on $350,000.
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Are There Situations Where Life Insurance Is Taxable
There are certain situations when life insurance can be taxable. These are:
When you withdraw funds from your cash-value life insurance
Life insurance policies come in two types â term and permanent. Term life insurance policies do not include an investment component, but many permanent life insurance plans do. This inbuilt investment component is called cash value, and the money in this account grows on a tax-deferred basis.
The cash value is for you to use during your lifetime. Your beneficiaries receive only the death benefit upon your death, not the cash value. You can tap into your policyâs cash value through a loan or withdrawal or by surrendering the life insurance policy.
Your policyâs cash value is made up of two parts:
- The money that you paid in the form of life insurance policy premiums. This component, in life insurance parlance, is called the âpolicy basisâ.
- The money gained from interest. This component is referred to as the âabove basisâ and is subject to tax.
For instance, letâs say your policy has $30,000 in the cash value account. If you paid $25,000 in premiums, you have a policy basis of $25,000 and an above basis of $5,000. If you withdraw all of this money, you will have to pay income tax on the above-basis amount â $5,000, that is.
To sum up, when you withdraw from your policyâs cash value, you pay tax on the amount that is âabove basis.â Your life insurer will tell you how much of a withdrawal is âabove basis.â
The Value Of Life Insurance
When you buy a policy for your family, youre essentially purchasing peace of mind. Then, when you die, either your beneficiaries or your estate will receive a lump sum death benefit from the life insurance company.
This payment can go a long way to support your family during an emotionally and financially complicated situation by allowing them to:
- Repay outstanding debts, like a home or auto loan
- Meet day-to-day expenses
- Replace or supplement existing income
- Cover funeral costs
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Using Life Insurance To Reduce Tax On Your Final Return
Instead of naming someone as the beneficiary of your life insurance account, you may name your estate as the beneficiary.
- The CRA does not charge inheritance taxes.
- Whoever inherits your estate does not have to pay tax on it.
- If you have a life insurance policy, you can ensure it is used to cover your final taxes so your heirs can inherit as much as possible.
However, the agency requires your representative to file a final tax return on your behalf. For the purposes of this return, it assumes you have disposed of all of your assets, and it assesses your capital gains tax as relevant. Once those taxes have been settled, the remainder of your estate passes to whomever you have named in your will.
Benefit For Motor Vehicles Not Defined As An Automobile
Even if the vehicle you provide to your employee is not included in the definition of Automobile, there is still a taxable benefit for the employee for their personal driving.
You have to reasonably estimate the fair market value of your employee’s personal use of your motor vehicle, including the GST/HST and PST. A reasonable estimate is considered to be the amount an employee would have had to pay in an arm’s length transaction for the use of comparable transportation. It includes items such as the cost of leasing a comparable vehicle and any other related operating costs. For more information, go to paragraph 23 in Interpretation Bulletin IT-63R, Benefits, Including Standby Charge for an Automobile, from the Personal Use of a Motor Vehicle Supplied by an Employer After 1992.
Although other methods of calculating the value of your employee’s taxable motor vehicle benefit are acceptable, the CRA generally accepts that the employment benefit arising from the employee’s personal use of the vehicle will be considered reasonable if it is calculated using the rates shown under Reasonable allowance rates.
The standby charge and operating expense benefit calculations should not be used.
Depending on how your motor vehicle is used by your employee and the conditions that you place on the use of it, you may be able to calculate your employee’s taxable benefit using the Motor vehicle home at night policy.
Motor vehicle home at night policy
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Option 2 Collateral Loan Or Line Of Credit Corporately
A corporately-owned collateral loan or line of credit has the same basic structure as a personally owned equivalent. The lender will use the life insurance policy as collateral and the corporation receives the proceeds of the loan tax-free.
However, one significant additional advantage is the ability to credit an additional capital dividend account credit. When you pass away, the corporation receives a credit to the CDA equivalent to the face amount of the policy minus the adjusted cost basis . When there is a collateral loan or line of credit against the policy it creates an additional credit equivalent to the amount of the loan, allowing additional assets to flow out of the corporation tax-free.
For example: the company owns a $5,000,000 key man universal or whole life permanent insurance policy on one of its executives.
- The business advances a collateral loan for $750,000, which is received tax-free by the corporation.
- The interest is capitalized , while the corporation uses the funds for other business purposes.
- When the executive passes away, the loan balance is $900,000.
Since the collateral assignment did not affect the underlying life insurance policy, it continued to grow tax-sheltered and was worth $5,500,000 on death.
What Are Your Responsibilities
If you provide benefits to your employees, you always have to go through the same steps. If a step does not apply to you, skip it and go on to the next step:
- determine if the benefit is taxable
- calculate the value of the benefit
- calculate payroll deductions
In this guide, “employee” includes an individual who holds an office, unless otherwise noted.
Determine if the benefit is taxable
Your first step is to determine whether the benefit you provide to your employee is taxable and has to be included in their employment income when the benefit is received or enjoyed.
Whether or not a benefit is taxable depends on whether an employee or officer receives an economic advantage that can be measured in money, and whether that individual is the primary beneficiary of the benefit.
For more information on the term primary beneficiary, see paragraphs 2.14 and 2.23 to 2.25 of Income Tax Folio S2-F3-C2, Benefits and Allowances Received from Employment. For some common examples of taxable benefits, see Chapters 2 to 4 of this guide.
The benefit may be paid in cash , or provided in a manner other than cash, such as a parking space or a gift certificate. For more information and examples, go to Pensionable and insurable earnings.
The manner in which you pay or provide the benefit to your employee will affect the payroll deductions you have to withhold. For more information, see Calculate payroll deductions.
Calculate the value of the benefit
You do not have to include the GST/HST for:
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Is Life Insurance Payout Taxable In Canada
Back in the day, life insurance helped parents provide for their children in the event that a parent passed. As time has gone on, Canadian incomes have gone up and more people are getting the hang of life insurance.
These days, many people consider life insurance options as a way to protect their money from higher taxes. They also consider it great for helping with financial wishes later in life and during retirement.
The 2017 edition of the Canadian Life and Health Insurance Facts shared that more than 22 million Canadians have life insurance. Life insurance benefits came to $12 billion, with $6.9 billion paid as death benefits and $5.1 billion paid to living policyholders.
Tax Implications: Naming Your Estate As Your Beneficiary
On the other hand, there could be tax implications if your death benefit goes towards your estate instead of directly towards a person. This can happen if you list your estate as your beneficiary or all your named beneficiaries die before you do.
In this case, the amount could be subject to tax, and there may be additional settlement costs during the money distribution process.
Therefore, itâs a good idea to appoint beneficiaries directly on your life insurance policy. By doing so, you can prevent added fees and taxes and speed up the overall settlement process.
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You Don’t Have A Beneficiary
When setting up your life insurance policy, you should always name a beneficiary. If not, your estate will be designated as the beneficiary and your death benefits may be subject to taxation.
The best way to avoid a tax payment to the CRA when the executor of your estate files your final tax return?
Whenever your relationships and financial responsibilities change, remember to update your life insurance policyâs beneficiary information.
Do You Pay Taxes On The Cash Value Of A Whole Life Insurance Policy
Yesif you surrender your life insurance policy and the cash value exceeds the adjusted cost base of the policy .
Permanent life insurance policies can accrue cash value, which you can get by cashing out your policy. When you surrender a permanent policy, you exchange your death benefit for a cash payout from your insurance company.
In this situation, it is taxed as ordinary incomenot capital gainssince the government counts the cash value as income.
While premiums are not tax-deductible, a permanent policy is still a valuable place to invest tax-deferred. By accumulating interest, it generates even more wealth for their beneficiaries.
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Are Cash Value Withdrawals Taxable
Life insurance policies fall into two main categories: term policies that pay a benefit upon death within a set period of time and permanent life policies that pay a death benefit and may accrue cash value as well. If you have a permanent life policywhole life, universal life or variable universal lifewith an available cash value or face value, you can typically withdraw at least some of the cash without incurring income tax.
Here’s the catch: Cash withdrawals from your policy could be taxableor partially taxableif your withdrawal exceeds the amount you’ve paid in premiums. Suppose you’ve paid $10,000 in premiums over the years and, with interest and dividends, your policy now has a cash value of $14,000. If you withdraw $11,000 from the cash value of your policy, you will pay income tax on $1,000, the amount you’ve withdrawn that exceeds your total premium payments.
Withdrawing cash from your life insurance policy can have repercussions, both to your taxes and to your policy. Study up on your options before you make this move to avoid any unwanted consequences.
Important Information For Customers Whose Tax Residence Is Not Exclusively In Canada
Canada has enacted legislation which has been incorporated into the Income Tax Act which is intended to reduce tax evasion and improve tax compliance around the world.
Effective July 1, 2014, Canadian financial institutions were required to begin collecting information to report to the Canada Revenue Agency on certain financial accounts held in Canada by U.S. persons as defined under U.S. tax legislation known as FATCA .
Effective July 1, 2017, Canadian financial institutions were also required to begin providing information to the CRA regarding certain financial accounts held in Canada by persons whose tax residence is outside of Canada and the U.S. under rules known as CRS .
Insurance and annuity contracts that are reportable to the CRA include non-registered life insurance policies with cash value and annuity contracts held by individuals or entities resident for tax purposes in countries other than Canada or entities with primarily investment income controlled by persons who are tax resident in a country other than Canada.
As a customer of Empire Life, we will ask you about your tax residency status when you invest with us or buy policies with cash value. Empire Life cannot advise you as to your residency for tax purposes.
This document should not be construed as providing tax, legal or financial advice.
For more information about FATCA, see these websites:
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