Tax Exemption vs Life Insurance in Ontario
Most Canadians today consider life insurance one of the more essential aspects of financial planning. The benefits of life insurance could go a long way if something terrible were to happen. It could help pay for your kid’s college tuition or allow the family to maintain a steady household income.
While most people are aware of the importance of life insurance, not everyone knows the type of insurance right for them. And for those who know which insurance to get, they can’t help but ask, is life insurance taxable in Ontario?
Types of Life Insurance
Some life insurance premiums that you can purchase include:
1. Term Life Insurance
Term life insurance costs less than most life insurance premiums. It protects you for a particular period. At the end of your coverage, you can renew your coverage at a higher cost, or you could cancel. Alternatively, you can convert it to permanent life insurance.
Getting term life insurance is less expensive than buying permanent life insurance. It also has a lower initial cost than permanent life insurance, so it’s so popular amongst people just starting a family. Is life insurance taxable in Ontario if it’s term life insurance?
2. Participating Life Insurance
You may know this as permanent life insurance. It protects you permanently so long as you keep up with your premium payment.
Permanent life insurance is also called participating life insurance because of how it works. Your premium, together with premiums from other life insurance policy owners, goes into a single participating account. The company’s investment team manages the participating account and invests it in raising the value.
The participating account covers your potential dividends and your death benefits. Dividend payouts are not always guaranteed, but they can go a long way if you receive any. You can use it to reduce your premium payments, buy more coverage, or take it out as cash. Any cash you withdraw from your policy may be taxable.
Universal Life Insurance
This is also a type of permanent life insurance. The coverage lasts as long as you keep up with your premiums. With universal life insurance, you benefit from a permanent life insurance policy and a tax-advantaged investment component.
Universal life insurance offers you flexibility. You can choose a premium schedule you prefer, the amount you’re willing to pay, and the investment plan that fits your risk profile.
Is Life Insurance Taxable?
Is life insurance taxable in Ontario? This question is often asked by Canadian citizens looking to buy life insurance. If you already own life insurance and you’re unsure of how tax laws apply to it, then here’s your answer.
Do you need to report your life insurance policy on your yearly tax returns? Will taxes affect your life insurance policy years down the line?
If you have a life insurance policy or think of buying one, you need more than a basic understanding of the policy. That way, your family (or any other beneficiary) can enjoy the money to the fullest.
So is life insurance taxable in Canada? The simple answer is no, and the long answer is sometimes. Life insurance is primarily considered non-taxable in Canada. This means that your beneficiaries can enjoy the full death benefit. Since life insurance is non-taxable, it implies that beneficiaries don’t need to pay income tax on the death benefit they receive.
The size of the policy, your family, or whoever else you’ve named as a beneficiary does not matter. Both small and larger-sized insurance policies are non-taxable. You may be wondering what if I got a term policy and not a permanent life insurance policy? There’s nothing to worry about; both policies are non-taxable.
Since life insurance policies are exempt from tax, it means you don’t have to report any interest you gain on the death benefit when filing your tax returns. Although life insurance is mainly exempt from tax, there are some exceptional circumstances where your life insurance will be taxed.
Situations where you’ll need to pay tax on your life insurance:
One unchangeable fact of life is that there’s an exception to every rule. Most life insurance does not require any tax payments except in the situations listed below.
1. When you have no beneficiary.
If you fail to appoint a beneficiary to your life insurance policy, your estate will be automatically selected as the beneficiary on your passing.
If this happens, then the death benefit may be subject to tax. The easiest way to avoid this is to make sure you select someone as your trusted beneficiary.
2. Loan Collateral
The second reason you may pay tax on your insurance policy is — putting down your life insurance policy as loan collateral. This means that when you pass, the loan provider will collect the death benefit from your provider and use that to pay off the loan.
Your family or your beneficiary will have to pay taxes on any outstanding loan balance. In other words, if the loan is more than policy, then the due compensation from the loan after the death benefit has been collected may be subject to tax.
3. When you choose to sell your policy
Individual provinces in Canada (Saskatchewan, Quebec, Nova Scotia, and New Brunswick) offer the opportunity to sell your insurance policy to someone else. On selling the policy, the buyer receives the death benefit and the premium. The money you receive from selling the policy may be subject to tax.
Five benefits of life insurance.
There are several reasons why you should have life insurance. Here are some of them.
It is tax-free
The question is that life insurance taxable in Ontario has already been answered in the previous section, and you know the answer is no. Life insurance is a lump sum your family/beneficiaries will receive in the form of a death benefit. They also don’t need to report the money when filing their tax returns.
It’s a great way to cover the living expenses of your dependents
An expert recommendation is that your life insurance should be seven or even ten times more than your annual income. With a policy, or several policies that size, your kids, your partner, and any other beneficiary should be set when it comes to their living expenses and even some significant costs. If your insurance policy is enough to cover the cost of sending your child to college, then they won’t ever have to bother with student loans.
Your life insurance can take care of funeral costs
The cost of a funeral can range anywhere from $5,000 - $15,000. Many people do not have the savings to cover such an expense, and as a result, funerals end up as a severe financial burden. If you do own a life insurance policy, your beneficiary can use the policy to take care of the burial expenses. That way, they won’t have to touch their savings.
You can get insurance policies for terminal and chronic illnesses
Some insurance companies offer endorsements on their policies. These endorsements or riders can be added to your policy to adjust or enhance your coverage, as they are sometimes known. An example of a rider you can add is the accelerated benefits rider. It allows you to access some, and in some cases, all of your death benefits in specific circumstances.
If you were diagnosed with a terminal illness, for example, the accelerated benefits rider can allow you to claim your death benefit so you can put it to use. You can use it to pay for your care or any other expense that may have popped up because of the illness.
Insurance Policies can act as a supplement to your retirement savings plan
If you buy a universe, whole, or variable life insurance policy, it can increase in cash value and provide death benefits. As the cash value continues to increase with time, you can use it to pay for some of your expenses. You could use it to make a payment on a home, buy a car, or dig into it when you’re retired (but only if you need to).
A life insurance policy can help to supplement your retirement savings. However, you should never consider it a replacement for having an IRA or a 401(k). Not to mention, life insurance policies that increase in cash value are much more expensive than policies with no savings component like the term life insurance policy.
Conclusion
A common misconception that exists is that life insurance is for the wealthy. But the truth is life insurance can give your loved ones some financial breathing when you pass away. Your income level doesn’t change that.
Now we can easily answer, Is life insurance taxable in Ontario? Life insurance is more affordable than people realize. If you’re considering getting insurance coverage, contact My Insurance Broker today for all your insurance coverage plans.