If you are named the beneficiary in someone’s life insurance policy, you may wonder what impact receiving the proceeds from the policy will make on your tax return. Will you have to pay taxes on the proceeds or report receiving the death benefit on your taxes? How much of an effect will it have on you?
Suppose you expect to receive a life insurance death benefit or are purchasing life insurance and going through naming your beneficiary. In that case, you need to know how the proceeds from life insurance policies are treated at tax time.
Read this article to learn more about taxes and life insurance in Canada, then reach out to us at Hometown Life Insurance for more help.
Do Beneficiaries Pay Taxes on Life Insurance Benefits in Canada?
No, beneficiaries do not have to pay taxes on the proceeds from any life insurance policies they receive in Canada. It does not matter if the life insurance policy was a permanent or term policy, and the income and financial situation of the beneficiary does not matter – life insurance proceeds are not taxable in Canada.
You can decide who will be your beneficiary, or you can name multiple beneficiaries. If you have more than one, the proceeds from your life insurance will be split evenly among your beneficiaries unless you have determined a proportional split.
You can name your spouse, partner, child, grandchild, or friend as your beneficiary, or you might consider naming a charitable or educational institution instead.
Critical to Name a Beneficiary
There is a situation where the proceeds from a life insurance policy will be taxed. If no beneficiary is named for the policy, the death benefit will go into the estate of the deceased. Once it is part of the estate, it is treated the same as other estate property – which means it will be subject to the estate administration taxes and other fees.
Naming a beneficiary, or beneficiaries is critical to protecting this asset from taxes. Since the beneficiary will not be taxed on any life insurance benefits they receive, naming one avoids your heirs having to pay taxes on your life insurance.
Since one of the goals of buying life insurance is to leave your heirs or beneficiary with the amount you have intended, you want to avoid paying taxes to diminish the amount they receive.
How to Name a Beneficiary
It is easy to name your beneficiary. Simply identify and list the individual when you purchase your life insurance policy. Remember you need to name a beneficiary for each life insurance policy you purchase, even if you intend to use the same one for each policy.
If you fail to list a beneficiary, it will default to your estate, leaving your heirs in the position of paying taxes on the proceeds from your life insurance. If you are not sure if you named a beneficiary for your life insurance policy or if you want to make a change to your beneficiary, call your agent or insurance company for help.
It is a best practice to review your beneficiaries periodically – that way, you will stay ahead of any changes you would like to make and correct any potential errors you find, like forgetting to list a beneficiary.
Contingent Beneficiaries
Another way you can protect your beneficiary from having to pay taxes on the proceeds from your life insurance is by naming a contingent, or alternate, the beneficiary. If your beneficiary predeceases you or dies at the same time as you, a contingent beneficiary would be necessary. If none is named, the proceeds from your life insurance policy will go into your estate to be settled with the rest of your assets according to the terms of your will and subjected to taxes.
Revocable or Irrevocable Beneficiaries
When you name your beneficiary, you can either name them as revocable or irrevocable. A revocable beneficiary can be changed by the policyholder whenever they desire without approval by the beneficiary. Unless in Quebec, a beneficiary is automatically revocable unless you designate otherwise.
An irrevocable beneficiary needs to approve of changes to the life insurance policy before they can be made. The policyholder cannot change the beneficiary to another without the written consent from the irrevocable beneficiary.
Beneficiaries who are Minor Children
Sometimes you may want to name your child as your beneficiary, but they may be of minor age when you purchase the life insurance policy. In that case, you can still name them as the beneficiary, but if you die while they are still underage, the funds will be distributed to a trust managed by the province or territory.
You may also set up a trust yourself, which allows you to control who is named as trustee or administrator to manage the fund until your child reaches adulthood or the designated age.
Final Thoughts
You and your beneficiary can relax, knowing the proceeds from your life insurance benefit will not be taxed. Your beneficiary will not have to worry about how it will affect their income or tax return, and you can be assured they will receive the full amount of the benefit you have purchased, rather than a portion going to taxes.
Be sure you have named a beneficiary for each life insurance policy you own. If not, the death benefit will default to your estate, where it will be taxed and distributed according to your will. That also means a delay in the funds getting to your beneficiary since they will be included in the estate process instead of being sent directly from the insurance company to the beneficiary.
It’s easy to name your beneficiary – ask us for help if you aren’t sure how to do it.
How do I Learn More?
To learn more about taxes, life insurance proceeds, and naming a beneficiary in Canada, contact the experts at Hometown Life Insurance. Our licensed experts will be happy to answer any questions you have.
External Links:
- https://ottawahumane.ca/donate/a-legacy-for-the-animals/making-a-gift-of-life-insurance/
- https://www.canada.ca/en/financial-consumer-agency/services/insurance/life.html
- https://www.canada.ca/en/financial-consumer-agency/services/insurance/get-insurance.html
- https://www.cba.org/Sections/Wills,-Estates-and-Trusts/Articles/2019/In-trust-accounts
