Having proper life insurance is so important for your family and your overall financial planning, but it can be complicated. Taxes are a critical aspect of life insurance benefits to consider in your plan. Proper planning in advance can help ensure you maximize your benefits from your life insurance investments.
If you have questions about how your life insurance benefit will be taxed, if you need to designate a beneficiary, or how cash withdrawals affect your taxes, you are not alone. These are common questions when considering your life insurance options, and it is important to have the right information.
Read on to learn more about taxes and your life insurance benefits, then contact the experts at Hometown Life Insurance for more help.
Is Life Insurance Taxable in Canada?
Buying life insurance provides you peace of mind knowing your family will be cared for after your death. But will they be taxed on the monies received from the death benefit of your life insurance policy?
Death Benefit
In general, the government of Canada confirms most life insurance proceeds received after someone’s death are not taxable. This is true regardless of the amount of the death benefit or the income level of the beneficiary at the time the benefit is paid.
In fact, in Canada, most inheritances and gifts are not taxed. Check with your agent or financial advisor for more details.
Cash Value Withdrawals
If your life insurance is a permanent policy that accrues cash value, any cash value withdrawals you take from the policy can be taxable. If you earn interest on the investments of the policy, that interest is taxable.
In the same way, if your beneficiary receives interest earnings from the policy, those earnings are considered taxable income and would need to be reported to the Canada Revenue Agency.
If you decide to take a cash-value withdrawal, make sure you understand first how it will be taxed. If you have taxable earnings from your insurance policy, your insurance company will send you or your beneficiary a T5 slip to report the earnings on your tax return.
Do I Need a Beneficiary?
It is a best practice, although not mandatory, to select a beneficiary for your death benefit when you purchase your life insurance policy. You can select a contingent beneficiary, or alternative beneficiary, in case your beneficiary dies at the same time as you or predeceases you.
You are allowed to name more than one beneficiary for your death benefit. If you have more than one beneficiary listed at the time of your death, the death benefit will be divided among them based on the proportions you identified when you named them.
Why you Should Always Name a Beneficiary for Your Death Benefit
You do not need to select a beneficiary for your life insurance policy, but if you do name one before you pass, your estate will automatically be named the beneficiary. If this happens, it means the death benefit may be subjected to estate taxes under your estate.
The death benefit becomes part of your estate in these cases, so it will be distributed according to your will. It is subject to creditors and estate taxes.
Because of this, it is better to name a beneficiary for the death benefit of your policy rather than allowing it to go to your estate, where it is subject to taxes. By selecting and naming your beneficiary, you remain in control of how your death benefit is distributed and taxed.
How do I Name a Beneficiary?
It is easy to select and list your beneficiary for your life insurance policy. If you are going to purchase a new policy but have not yet bought it, you can name your beneficiary when you take out the policy. It will be an additional piece of information you will fill out along with the other paperwork and is a simple process. You will need some basic details about your beneficiary, such as their name and address.
If you already own a life insurance policy but need to name a beneficiary now, you can contact your agent or insurance company for help. You may be able to add your beneficiary yourself using your carrier’s online portal.
Remember to add a beneficiary to each life insurance policy you own. It is a good idea to audit your policies from time to time to ensure you have named a beneficiary and the beneficiary remains the correct one.
You can name a revocable or irrevocable beneficiary for your life insurance policy. A revocable beneficiary is one you can change at any time without informing the beneficiary. On the other hand, an irrevocable beneficiary cannot be changed without the written consent of the beneficiary.
What if my Desired Beneficiary is Under the Legal Age?
Consider establishing trust if your beneficiary is a minor. If you do not, and you pass while your beneficiary is still a minor, the government will hold the death benefit, plus interest it accrues, in a trust until the beneficiary reaches the age of majority. By creating the trust yourself, you retain control of determining who the trustee is and other important administrative details.
Final Thoughts
Life insurance planning is critical to your family and your peace of mind. Understanding more about how taxes will affect your death benefit is helpful as a part of your financial plan. Working with your agent, plan now to name your beneficiary and work through any planned cash withdrawals to make the most of your life insurance benefit.
It is best to understand the consequences of naming your estate or an individual as the beneficiary and planning ahead to avoid tax complications. With advance planning, you can maximize the benefits of your life insurance for your family and estate.
How do I Learn More?
Now that you know more about taxes and life insurance benefits, you can contact the experts at Hometown Life Insurance for more information. Our licensed professionals will be happy to answer any questions you have.
Sources:
- https://www.canada.ca/en/revenue-agency/services/tax/individuals/topics/about-your-tax-return/tax-return/completing-a-tax-return/personal-income/amounts-that-taxed.html
- https://www.canada.ca/en/revenue-agency.html
- https://www.canada.ca/en/revenue-agency/services/tax/individuals/topics/about-your-tax-return/tax-return/completing-a-tax-return/personal-income/line-12100-interest-other-investment-income/line-12100-earnings-on-a-life-insurance-policy.html
- https://www.canada.ca/en/financial-consumer-agency/services/insurance/life.html
- https://discover.rbcinsurance.com/will-my-loved-ones-pay-tax-on-life-insurance-proceeds/
