Is premium paid life insurance tax deductible?

What is life insurance?

Life insurance plays a crucial role in offering liquidity to your estate by allowing the payment of funeral expenses,debts, and money to your dependents to replace your earnings.

Deductibility of premium

Premiums paid on life insurance policies are generally not deductible. This changes, however, if interest in a life insurance policy is assigned to a financial institution (i.e., a chartered bank, trust company or credit union) as required collateral on a loan or indebtedness. In that case, the policyholder may deduct a portion of the premiums paid, as long as the interest on the loan is deductible. The policy holder and borrower should be the same individual or corporation.

If you are self-employed or have a corporation, and you pay life insurance premiums on behalf of your employees, it is tax deductible. It then becomes a taxable benefit to employees, subject to Canada Pension Plan deduction, but not to Employment Insurance.

There are two basic types of life insurance:

Term policies: These policies provide insurance protection for a specified period of time or up to a specified age. They typically have no explicit investment component and provide the policyholder's beneficiary with a tax-free fixed sum on their death. Term insurance policies generally have no guaranteed cash values and are usually not participating. Term insurance policies typically have a fixed premium for the duration of the policy. They may contain features such as a guaranteed right to renew the policy at the end of the term, or the right to convert it to permanent insurance. The latter is subject to certain conditions.

Permanent policies: There are various types of permanent insurance policies. Some policies are referred to as participating policies, where the policyholder may receive benefits in the form of policy dividends. Others, referred to as non-participating policies, do not pay policy dividends. In addition, some policies provide for significant flexibility and transparency with respect to investment options and cash value accumulation. These policies are collectively referred to as universal life policies.

Depending on the terms of the policy, premiums for permanent policies may be fixed over the policy's lifetime or may increase over time.. Generally, premiums for permanent policies are higher than premiums for term policies in recognition of the need to pay a death benefit at some point, and to accumulate savings within the policy.

One added benefit of permanent insurance policies is that the investment component usually has a cash surrender value, which can provide funds before death. You can borrow against or withdraw this cash surrender value to supplement your retirement income or for emergencies, but there may be an associated tax cost.

Adjusted cost basis (ACB) of life insurance policies for tax purposes

The premiums paid on a life insurance policy are added to the ACB, while money withdrawn reduces the ACB of the policy.The ACB calculation in Canada is complex and therefore Canadian insurers maintain the calculation on behalf of their policyholders, and issue a tax slip, for any taxable amounts withdrawn in the year.

Beneficiary designations

Unlike other types of investments, life insurance policies allow the policyholder to designate beneficiaries under the policy, which may be advantageous compared to other investments. Designating beneficiaries may protect the policy from creditors and exclude the proceeds from the estate's value when calculating probate tax.

Choose the best life insurance, and grant yourself some peace of mind!