Is Life Insurance Taxable in Canada? Experts Answer (2022)

Peer reviewed by Erik Heidebrecht, Certified Life Insurance Advisor
In This Article

Key takeaways:

  • Life insurance death benefits are usually not taxed in Canada.
  • Life insurance policies that don't name a beneficiary may have the payout taxed.
  • Permanent life insurance policies with a cash value are more likely to be taxed than term life insurance.
  • Any interest or dividends earned on life insurance policies may be taxed.
  • Withdrawals against your policy may be taxed.

Life insurance is usually not taxable in Canada

Life insurance payouts are not usually taxable in Canada, no matter the size of the payment. The death benefit is paid directly to beneficiaries in one tax-free lump sum. Beneficiaries don't need to report the payout as additional income on their Canadian tax return.

This is because most inheritances in Canada aren't taxable. There is no death tax or estate inheritance tax that beneficiaries need to pay out.

That said, anything outside of your life insurance payout could be taxed, such as when you withdraw money prematurely against your policy's cash value (more on that in the next section).

Will I be taxed if I use my policy as collateral for a loan?

No, you won't be taxed if you get a loan by using your life insurance policy as collateral.

And in case you were wondering: it's true, you can use your permanent life insurance policy as loan collateral in Canada.

It's a way to access funds for your retirement or a kitchen renovation, if you need to, though experts caution against doing so.

Caveat: when you pass away the loan is paid off first and then the remaining funds go to your beneficiaries, which won't be taxed.

When is life insurance taxable in Canada?

Here's when life insurance is taxable in Canada:

  1. You don't name a beneficiary in your life insurance policy.
  2. You withdraw from the cash value of a permanent life insurance policy.
  3. You cancel your permanent policy (in some cases).
  4. Your beneficiaries get interest earnings from your policy.
  5. You sell your permanent life insurance policy while you're still alive.

In short, the tax implications of a life insurance policy change depending on which type of life insurance you buy: term or permanent. 

Here's a short refresher on the two types: term life insurance policies last for a specific period of time such as 10 or 20 years. Permanent life insurance offers lifetime coverage and comes in two main types: whole and universal.

Let's look in more detail when life insurance can be taxed in Canada.

1. You don't have a beneficiary

When setting up your life insurance policy, you should always name a beneficiary.

If you don't name a beneficiary in your policy, your estate will be designated as the beneficiary and your death benefits may be taxed.

Here's what happens when your estate is the beneficiary of your policy:

  1. If you have a will, the life insurance payout will be added to the overall assets.
  2. The estate (overall assets) will be subject to probate fees, which are a kind of taxation.
  3. These assets will then be divided between the people listed as the beneficiaries in that will.

What’s the best way to avoid a tax payment when the executor of your estate files your final tax return? 

That way your money is going exactly where you want it to go, instead of to the Canada Revenue Agency (CRA). 

2. You withdraw from a permanent policy's cash value

Permanent life insurance policies can accumulate a cash value that earns interest over your policy term.

Usually, this cash value is invested to increase the policy's worth.

Let's say you decide to withdraw from this cash value. Maybe you really need the money, maybe you want to use it to pay your life insurance premiums.

There's a whole host of reasons why you might want to withdraw some (or all) of your cash value.

And there are also many reasons why it might not be a good idea—despite what TikTok influencers recommend, in a trend calling borrowing against life insurance.

The cash value of your policy will be taxable if your withdrawal affects the "adjusted cost base" of your policy (what your policy was originally worth).

3. You surrender your permanent policy

While your life insurance policy is active, any investments within are tax-sheltered.

When you cancel your policy, though, you may be taxed on any cash value that's built up.

The cash value will be taxed as income, by the way, not capital gains.

Cancelling your permanent life insurance policy is also known as surrendering your policy or cashing it out.

4. Your beneficiaries get interest earnings

Your beneficiaries may receive interest earnings from your policy, along with your death benefit. This interest can then be taxed by the CRA as income.

Income earned as interest is usually taxable by the Canada Revenue Agency (CRA). The growth of your cash value, while it’s still locked up in your permanent life insurance policy, is exempt from taxation.

5. You sell your permanent policy

It's possible to sell a permanent life insurance policy in Canada while you're still alive, but you can only do so in Quebec right now.

This is generally done if the policyholder needs cash, can't afford to continue paying their premiums or no longer wants the policy, for example.

This is because earnings on the sale are considered income and you'll need to report it to the CRA.

Reminder: it's not legal to sell your permanent life insurance policy in most provinces and territories in Canada; Ontario, Alberta, Manitoba and every other province and territory do not allow it.

There is a movement in Ontario to make it legal. If passed, the proposed Bill 219 would allow Ontario residents with life insurance to sell their policies.

It used to be legal to sell your life insurance policy in New Brunswick, Nova Scotia and Saskatchewan, but this was abolished by 2020.

How do I report a life insurance payout on my tax return?

You don't need to report a payout on your tax return unless you receive interest earnings on the death benefit, which is specific only to a permanent policy.

If a payout needs to be reported, the insurance company will automatically issue a T5 slip.

If you surrendered your permanent policy, this form would be issued to you and it will go to your beneficiary if you pass away.

Line 121 of the form will outline the interest earnings that would need to be reported, according to the Canada Revenue Agency.

Can I use life insurance to reduce tax on my final tax return?

Yes, it is possible to use life insurance to reduce tax on your final tax return in Canada. And by final tax return, we mean after you pass away.

To do so you need to:

  • Name your estate as your beneficiary in your life insurance policy, instead of a person.
  • Your estate isn't charged inheritance taxes by the CRA.
  • The beneficiary of your estate won't have to pay taxes on it.
  • You can require that your policy's death benefit is used to for any final taxes, so your estate won't have to cover them.
  • Meaning your heirs won't have to use your estate to cover taxes.

Using life insurance to reduce tax isn't a good bet

Using permanent life insurance to reduce tax on your final return isn't a great strategy because most Canadians don't need permanent life insurance.

In a recent study, we found that 22% of Canadian parents bought permanent life insurance. 

But permanent policies aren't great because they're very expensive and if you're looking to make money from investments, it's better to max out tax-sheltered accounts like TFSAs and RRSPs first.

So why pay those sky-high permanent premiums for the rest of your life when you don’t have to?

Term life insurance is a much better value for the average Canadian family.

Here’s a snapshot of how much it costs to buy term versus whole life insurance, a type of permanent life insurance: 

$250,000 20-year term life insurance $250,000 whole life insurance
Male, aged 30 $18/month $135/month
Female, aged 30 $15/month $121/month
Male, aged 40 $28/month $204/month
Female, aged 40 $22/month $178/month
Male, aged 50 $72/month $327/month
Female, aged 50 $51/month $279/month

The methods that companies use to calculate the cost of your life insurance premiums will vary a bit, but it's clear that term life insurance is the more affordable option that suits most Canadian families best.

PolicyMe offers some of the most competitive term life insurance rates in Canada, with an easy online quote and application process.

Is tax added to my monthly premiums?

Your beneficiary isn't the only one who doesn't have to pay tax for your life insurance. Your life insurance premiums are tax-free too. 

That's one of the big advantages of buying life insurance in Canada.

When you pay your monthly premiums, you won't be charged HST. That's because, like other financial services, life insurance premiums are exempt from GST/HST.

How to make life insurance easier for your beneficiaries

Losing a loved one is hard, but know that you can make claiming your life insurance easy for loved ones by taking these simple steps: 

1.  Don’t forget to name your beneficiaries

Properly filing the name of your beneficiary or beneficiaries with your life insurance company can speed up the settlement process and help avoid probate, associated costs and most outstanding debts owed.

2. Let your beneficiaries know that you have them covered

Regardless of who you choose as your beneficiary, be sure to let them know. We’re sure you’ll get lots of love and gratitude in return. 

What’s even more helpful? Provide them with your insurance provider's details so they can file a death claim easily without searching through your paperwork.

3. Put everything in writing and record every detail. It’s worth the extra effort 

Be specific when it comes to how you want your policy's death benefit doled out. 

For example, if you want your children to receive your life insurance payout, list their legal names and social security numbers rather than simply listing “children.” 

If you wish to name a charitable organization as the beneficiary, outline the organization's name, address and tax ID number.

4. Name your secondary beneficiaries too. That way your death benefit will always find a tax-free home

There are two common types of beneficiaries:

  • Primary
  • Contingent, also referred to as secondary

A primary life insurance beneficiary is the individual who is first in line to receive your life insurance payout. Typical examples include your spouse, children or other close family members.

If your primary beneficiary passes away before or at the same time as you, a contingent (or secondary) beneficiary will receive your death benefit tax-free if you name them on your policy. 

5. With every life change, update your life insurance too 

Common reasons to update your life insurance beneficiary include getting married, getting divorced, having a new baby or adopting a child. To amend your policy's beneficiary information, contact your life insurance agent for help.

When you fail to keep your beneficiaries up-to-date, someone other than your intended may receive your insurance payout.

PolicyMe makes it as easy as possible for your beneficiaries to claim their payout. Your beneficiaries simply need to complete the following steps:

  1. Notify us by email or by completing the form of their loss
  2. Complete the required claim forms and provide more documents if requested
  3. Wait for Canadian Premier to review your claim, follow up about any additional information required and process your payment.

In summary: Life insurance payouts are usually tax-free in Canada

When you buy a term or permanent life insurance policy, the proceeds won’t be taxed.

But if you buy a permanent policy, there are extra complications that may make the proceeds subject to taxation.  

In short, whether you'll be taxed on your life insurance in Canada depends on:

  • The type of policy you had
  • The money you paid into it
  • The payment you got from selling it
  • And if the policy had any cash value 

Now that you have the intel to help your loved ones when they need it most, it's time to get set up with a term policy that works hard for you when it really counts. 

At PolicyMe, we empower you to personalize your term life insurance policy that’s tax-free and works for your budget. And life insurance isn’t as pricey as you might think. Get a quote below and you may be surprised!

FAQ: life insurance and taxation in Canada

What type of life insurance is tax-free?

Death benefits from both term and permanent life insurance policies are not taxable in Canada, as long as a beneficiary's assigned. Any interest earnings on a permanent life insurance policy are taxable.

Is employee life insurance tax deductible?

Employee life insurance premiums are not deductible on individual employees' income tax returns. If you're a business owner who covers the cost of employee life insurance (also often referred to as group life insurance) and the premiums are listed as a reasonable business expense, they are tax-deductible.

Is life insurance considered an inheritance?

When you name a beneficiary, life insurance is not part of your estate, so it is not considered an inheritance. In fact, life insurance proceeds can be used to help pay for any debts associated with your estate. 

Is life insurance subject to capital gains tax?

When you have a permanent policy, such as whole life insurance, you’re purchasing a life insurance policy and sheltering cash that is invested by your insurance provider with a common goal to gain dividends on your premiums. Those dividends or earnings are subject to capital gains tax. 

Are foreign life insurance proceeds taxable in Canada?

Foreign life insurance policies are not treated the same as Canadian policies and often are subject to taxation. If you do own a foreign policy, ask your provider if they can provide written proof that your policy qualifies in Canada. 

If it doesn’t qualify, speak to a tax specialist to clear up any cobwebs about your policy and ask for advice about reducing potential taxes for your loved ones. 

Laura McKay

COO & Co-Founder

About the Author

What to read next