Tuesday, November 23, 2021

Is My Life Insurance Taxable

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Learn About The Tax Treatment Of Life Insurance

Is my Life Insurance Tax Deductible?

Your tax accountant will be happy to advise on all these matters. The tax treatment of your life insurance, in general, should be on the agenda for your annual or bi-annual meetings with your financial professionals.

A lot of money is left on the table because many taxpayers simply dont know about the tax advantages available to them through life insurance.

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You Are Life Insurance Beneficiary Who Receives Interest On A Death Benefit

Most life insurance payouts are made in one lump sum right after the death of the insured person. But some beneficiaries choose to delay the payout, or choose to take the payout in installments over time. When these delayed payouts include interest from the life insurer, the interest can be taxable.

Taxes On Life Insurance Dividend Payments & Cash Value

If you have permanent life insurance from a mutual insurance company, you may receive periodic dividends from the company. With mutual insurance companies, the policyholders are essentially the owners, so the company often distributes excess income in the form of annual dividends. Unless the amount of money you receive in dividends exceeds the amount youâve paid in premiums, life insurance dividend payments are not taxable.

In addition, with permanent insurance policies, each time you pay premiums, a portion of the premium goes towards the policyâs cash value. The cash value is essentially how much money you would receive if you decided to surrender the policy to the insurer. Its growth is tied to interest rates set in the policy terms and is tax-deferred.

You can also take a tax-free loan from the insurer using the policyâs cash value as collateral, so long as the loan doesnât exceed the cash value. However, if the loan amount exceeds the cash value, the policy might lapse and you would have to pay taxes on the loan.

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If The Beneficiary Is An Estate

If the policyholder names an estate as the beneficiary, the process gets more complicated. If the death benefit pushes the estates value over $11,580,000, your beneficiaries will have to file an estate tax return. Leaving the proceeds to an estate adds to its value, which could lead to higher estate taxes for your heirs. The proceeds left to a beneficiary may be taxable under the decedents estate, both Federally and on the state level in some cases, too. An estate tax may also be owed in cases where the beneficiary is not the estate.

Accommodation Or Utilities Provided By The Employer

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If you provide accommodation or utilities free of charge, it is a taxable benefit to your employee. The method you use to determine the value of the benefit depends on whether or not the place in a prescribed zone has a developed rental market.

Places with developed rental markets

Some cities and towns in prescribed zones have developed rental markets. When that is the case, you base the value of the benefit for any rent or utility you provide on its fair market value.

The cities and towns in prescribed zones that have developed rental markets are:

Cities and towns in prescribed zones that have developed rental markets

Dawson Creek
Yellowknife

Places without developed rental markets

In places in prescribed zones without developed rental markets, you have to use other methods to set a value on the housing benefit. The method you use depends on whether you own the residence or rent it from a third party.

If you provide both rent and utilities and can calculate their cost as separate items, you have to determine their value separately. Add both items to get the value of the housing benefit.

If your employee reimburses you for all or part of their rent or utilities, determine the benefit as explained below. Subtract any amount reimbursed by your employee and include the amount that remains in their income.

Accommodations you own

If you own a residence that you provide rent-free to your employee, report as a benefit whichever of the following amounts is less:

Note

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  • Person B the policy owner
  • Person C the beneficiary

When the owner of a policy appoints a fourth party another beneficiary the Goodman Triangle occurs, and their payout is considered a gift. Unlike life insurance payouts, gifts are subject to taxes, and the owner of the policy is responsible for that tax payment.

Heres an example:

Jerry has two children, Mike and Bob. Mike takes out a life insurance policy on Jerry for $1 million with the understanding that the payout is split between the two siblings. Bob is named the beneficiary but isnt listed as an owner of the policy.When the death benefit is paid out, Mike and Bob both receive $500,000. But because Bob isnt listed as an owner, his half is considered a gift from Mike the owner of the policy. Mike is now responsible for the gift tax on $500,000.

How can you avoid the Goodman Triangle?

To avoid running into the Goodman Triangle, list all beneficiaries as owners of the policy or register an irrevocable life insurance trust as owner of the policy. Youll need to pay a fee, but it keeps the death benefit separate from the estate and avoids gift taxes.

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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Take A Loan Or Withdrawal Without Paying Tax

Another life insurance tax benefit kicks in if you decide to borrow against your cash value. Although this type of loan isnt treated as taxable income, it will have interest charged by the insurance company until you pay it back, and each insurance company has its own rates. You can also choose not to pay the loan money back, although this would affect the amount of your life insurance payout to your beneficiaries. There are several approaches to consider when deciding whether to withdraw or borrow from your cash value. Its important to talk to your financial representative to decide which choice is best for you. Whole life policies have responsibilities and costs, but they offer a high level of predictability and reliability in terms of the guaranteed sum your beneficiaries receive. Make sure to choose a reliable company with a long track record of financial stability.8

Is Life Insurance Taxable If You Cash It In

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In most cases, your beneficiary wont have to pay income taxes on the death benefit. But if you want to cash in your policy, it may be taxable. If you have a cash-value policy, withdrawing more than your basis is taxable as ordinary income. Its best to check with your provider before you cash in some policies state cash withdrawals made in the first 15 years are taxable.

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Do You Pay Taxes On Life Insurance Premiums

Taxes on life insurance boil down to taxable income. Policyholders dont need to pay taxes until they profit from their policy. In other words, the policy basis or the policy payout amount is not subject to taxes.

However, policyholders must pay taxes when they generate income from their policy.

Consider this situation:

A policyholder no longer wishes to keep their coverage. As such, the policyholder surrenders their coverage. In this situation, the insurer ends the contract and returns the premium payments to the policyholder.

This transaction does not generate any taxes unless the policyholder receives an amount greater than their premium payments. For instance, the policyholder paid $10,000 in premiums. As such, those $10,000 are not taxable.

In contrast, if the policyholder receives $10,000 plus $1,000 in accrued interest, the policyholder would need to pay taxes on the $1,000. After all, the IRS considers interest payments as income. Therefore, the policyholder would need to pay the corresponding income taxes.

Should I Sell My Life Insurance Policy

A viatical settlement may be a good option if you can’t afford your policy. You may also want to consider selling if you have enough money saved to provide for your family and settle your debts and final expenses after you die. If your only beneficiary preceded you in death, it may make sense to sell your policy.

Even if you find yourself in one of these circumstances, there are some drawbacks to selling.

  • Difficulty securing a buyer. Life settlement brokers and companies may decline to buy if they don’t believe they can make money on the purchase. It may take a considerable amount of time to find a willing buyer.
  • Low value. Because offers on life settlements are just a fraction of the death benefit, you may not make enough from the sale to recoup the premiums paid.
  • Fees and commissions. Brokers and life settlement companies may take a considerable percentage of the payout for commission and fees, leaving you with an even smaller payout.
  • Increased income tax. Because the money received from a settlement is considered income, you may owe taxes or not receive your usual refund.
  • Increased annual income. Your income will go up the year that you sell your policy, and that could potentially impact your eligibility for receiving various types of public assistance like Medicaid.

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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:

Property Acquired Before 1991 Or From A Non

Are Life Insurance Proceeds Taxable?

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.

Example

You bought a passenger vehicle from a non-registrant and made it available to your employee throughout 2020. 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

Note

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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Situations When The Cash Value Is Taxable

Although uncommon, accessing more than the policy basis can trigger a considerable tax bill, so its worth knowing how and when this can happen. Here are three situations to look out for:

You surrender the policy

When you surrender a permanent life insurance policy, youre essentially canceling the coverage, and the insurer pays out the policys cash value, minus any surrender fees. The portion of the cash value that exceeds the policy basis is taxable. For example, if you surrender a $10,000 policy and the policy basis is $5,000, the IRS considers the additional $5,000 as income and taxes it accordingly.

You sell the policy

Selling your life insurance policy often called a life settlement can get you more money than surrendering it. This is because the policys sale price is not capped at the cash value amount, but rather based on a variety of factors, such as your life expectancy, the death benefit and the cost of the premiums.

The IRS levies two types of tax on the sale of a life insurance policy:

  • Income tax is due on any proceeds that exceed the policy basis.

  • Capital gains tax is due on any proceeds that exceed the policys cash value.

  • If you want to get out of a life insurance policy and buy another one, you may be better off trading it as part of a 1035 exchange a provision in the U.S. tax code that allows you to exchange similar properties without paying capital gains tax.

    You take out a loan against the cash value

    Putting Life Insurance Money In A Trust

    When you put your life insurance payout in a trust it is exempt from inheritance tax because it’s separate from your estate.

    This trust is managed by trustees, who will be chosen by you. This can be a solicitor or family members. They can then distribute the money according to your wishes.

    You may also want to write your life insurance policy in trust for a child in your family, who will only be able to access the money once they reach adulthood.

    If you plan your taxes accordingly, you could even arrange for your life insurance payout to help pay the tax bill on your estate after you die. For example, if the value of your estate is above the inheritance tax threshold, your family will have to pay tax on that amount. Your life insurance payout will be exempt from tax and could be used to cover the tax bill on the estate.

    If your finances are quite complicated then it is best you speak to an independent financial adviser to help you find a solution that works for you regarding taxes and your estate.

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    Can I Sell My Life Insurance Policy

    • Learn when you can likely sell your life insurance policy. Explore the benefits and drawbacks of selling and find out what other options may be available.

    During times of financial hardship, you may struggle to continue paying your life insurance premiums. Missing payments could result in the insurance company canceling your policy. You lose your death benefit, but you also end up wasting the money that you previously paid into premiums. One way to avoid cancellation is to sell your life insurance policy. For some people, selling is the best option. However, you need to fully understand how the process works before you enter into an agreement.

    Premiums Under Provincial Hospitalization Medical Care Insurance And Certain Government Of Canada Plans

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    You may be paying premiums or contributing to a provincial or territorial hospital or medical care insurance plan for an employee. The amount you pay is considered a taxable benefit for the employee. Report this benefit in box 14, “Employment income,” and in the “Other information,” area under code 40 at the bottom of the employee’s T4 slip. If you have to make payments to such a plan for amounts other than premiums or contributions for the employee, they are not considered a taxable benefit for the employee.

    If you are the former employer of an employee who has retired, any amount you pay as a contribution to a provincial or territorial health services insurance plan for the retired employee is a taxable benefit.

    Report this benefit under code 118, “Medical premium benefits,” in the “Other information” area at the bottom of the T4A slip.

    Any amount that the federal government pays for premiums under a hospital or medical care insurance plan for its employees and their dependants serving outside Canada is a taxable benefit. This also applies to dependants of members of the Royal Canadian Mounted Police and the Canadian Forces serving outside Canada.

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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.

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