Knowing how the cash value of your life insurance will be considered for taxation purposes is critical when planning how to access funds and manage your retirement. You may already know the proceeds of your life insurance policy received by your beneficiaries are not taxable, but is the cash value of life insurance taxable in Canada?
We will examine the tax status of the cash value of your life insurance policy in Canada, including ways that you can access and use your cash value without incurring a tax penalty.
Read on to learn more, then contact us at Hometown Life Insurance for additional information.
Is the Cash Value of a Life Insurance Policy Taxable in Canada?
Yes, the cash value portion of a life insurance policy in Canada may be taxed as income. However, there are alternatives to access your cash value in different ways that may not face tax penalties. Each of these ways to access your cash value has pros and cons to consider.
Before we dive into the various ways policyholders can access their cash value from their life insurance policies, we need to explain ACB or Adjusted Cost Basis. The ACB of your life insurance policy is the sum of the premiums paid on the policy minus the net cost of pure insurance that has accrued.
Put simply; any proceeds received from a life insurance policy that exceeds ACB are generally taxable.
Take out a Policy Loan
As the policyholder, you may be able to take a loan from your life insurance policy. This can differ from policy to policy, so you should first read your contract or check with your agent if you consider taking a loan from your life insurance policy.
Assuming your life insurance policy allows for policy loans, you may be able to access up to 90% of the cash surrender value of your policy in a loan. The interest rate may be higher than the rate would be through a traditional loan with another financial institution, however, so you should consider that factor in your decision, too.
Policy loans are only taxable under certain circumstances. When the ACB is less than the policy loan, the amount over ACB is taxable. Your insurance company will send you a T5 (Statement of Investment Income) slip so you can submit it with your tax filing.
Use Cash Value as Collateral for a Third-Party Loan
Banks and financial institutions can use the value of your life insurance policy as collateral on loan. This is a way to take advantage of the value of your life insurance without tax consequences – unless you default on your loan. If you were to default on the loan, you used your policy as collateral; the lender could force you to surrender the policy – at that time, you would face taxation on the surrender value.
Banks and lenders will often allow you to borrow up to 90% of your cash surrender value from your life insurance policy, so using your policy as collateral for a third-party loan can be a good way to derive more value from your policy.
If you pass away before repaying the entire loan, the remaining balance would be payable from the death benefit of your life insurance policy. Because of this, consider informing your beneficiary or beneficiaries of any outstanding collateral loans on the policy so they may plan ahead.
Use Cash Value to pay Premiums
If you have sufficient cash value accrued in your life insurance policy, you can structure it to pay your premiums for you. If the investment continues to grow, this could be a sustainable option to pay your premiums once you have owned the policy long enough for the cash value to support the payments.
Using your cash value to pay the premiums on the life insurance policy means it will not be taxed, so it is a good way to access the cash value in your life insurance policy. Ask your agent for details on how to do this and if your policy has enough value accrued to make this a viable option for you.
Take a Policy Withdrawal
Taking a policy withdrawal from your life insurance policy reduces the death benefit. This is a good option for someone who does not intend to repay the amount withdrawn, like with a loan. Rather, policy withdrawals reduce the death benefit the beneficiary will receive. Sometimes life circumstances change, and this can make more sense than leaving the cash value in the policy.
Withdrawing cash from your life insurance policy is considered a partial surrender, and gains over ACB are taxable on a proportional basis to the amount withdrawn. Depending on how much is withdrawn, you may not have to pay taxes on the amount.
Final Thoughts
While the cash value of your life insurance policy is taxable in Canada, planning ahead may allow you to find other ways to access your cash value without taking a tax penalty. You might consider a policy loan, withdrawal, or using it as loan collateral instead – or perhaps using your accumulated cash value to pay future premiums on your life insurance policy is the simplest option for you.
There are several options open to you, and your agent or financial advisor can help you find the best solution to help you access the cash value from your life insurance policy. It can be expensive to pay taxes on your cash value so be certain you plan to manage your taxes when accessing your cash value.
Discussing your plans with your beneficiary or beneficiaries is also helpful when considering accessing the cash value of your life insurance policy since it may change or reduce the death benefit of the policy. This way, everyone can be prepared.
How do I Learn More?
To learn more about taxes and to access the cash value of your life insurance policy in Canada, contact the experts at Hometown Life Insurance. Our licensed experts will be happy to answer any questions you have.
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