Life insurance is, unlike any other form of wealth transfer (aside from primary homes), paid completely tax-free and creditor-proofed to your beneficiaries. Whether your family receives a lot or not-so-much from your policy, it’s not included as income for the tax year that it is paid.

There are exceptions to some elements of that guaranteed. For example, naming your estate as the beneficiary does not protect your coverage from creditors, nor does naming a person with whom you have a business relationship.  However for the majority of Canadian policyholders, they can rest relatively well assured that their benefits aren’t going to create nasty and confusing tax implications for their family.

Policy dividends and cash values don’t affect Term life insurance policies, where the cost of insurance goes directly towards the death benefit and nothing more. However any whole life or universal policies where investments are made can have their policy dividends or cash values subject to tax if you receive any of that money as income in your current tax year.

So unfortunately for owners of these types of policies, their earnings can be subject to tax.

While a dividend or a payout may lead to extra fees with the CRA, investing that excess back into your policy may not.

Some policies allow you to take your cash value inherent in your policy and use it to purchase additional coverage or pay-off existing portions of your coverage. This is ostensibly money you would’ve received as a (taxable) payout otherwise. For individuals who see their financial needs expanding as their cash value does, this can be a viable way to expand your life insurance coverage without paying more money out of pocket – either to your insurer or the CRA.

If you are planning to surrender your insurance policy, learn a little about Adjusted Cost Base, or ACB. The ACB is the calculating of premiums paid less the actual cost of insurance. The ACB is the non-taxable portion of your cash surrender value that is indicated to have been what you actually paid for your life insurance.

Anything that isn’t part of the ACB is taxable on the year you surrender your policy. So, as an example, you cash out a policy for $150,000 today and the ACB is equal to $40,000, you will have earned an additional $110,000 as reported on your income.

It can catch many people off guard – likely because some parts of life insurance are tax-free (namely, the benefit) while the cash surrender value (less the ACB) is not. 

Take great care to consult with your advisor as to the tax implications of a surrender and set aside an according amount to settle that fee for when your taxes are due.