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What does tax deductible mean in Canada?
In Canada, an expense or cost that is tax deductible means it can be used to reduce your total taxable income. The lower your taxable income, the less taxes you’ll pay. For example, if you make $50,000 a year and you have $1000 in tax deductions, you’ll only pay taxes on $49,000 in income that year.
Common examples of tax deductions are contributions to a Registered Retirement Savings Plan (RRSP) or a First Home Savings Account (FHSA), childcare expenses, or business expenses for business owners. The deductions that you’re eligible for depend on your income level and employment situation, among other factors, and can vary from year to year.
Which leads to the question…
Are life insurance premiums tax deductible in Canada?
Unfortunately, for most Canadians, term life insurance premiums aren’t tax deductible according to the CRA.
Premiums refer to the monthly fees you pay to your insurance provider to keep your term life insurance policy in effect. It's a personal expense, so just like the cost of your car insurance or your latest purchase at the mall, you can’t deduct the amount from your taxable income.
This can be surprising, especially for those Canadians who may also think that private health benefit premiums are tax deductible. Premiums for private health insurance plans can be claimed on your tax return, but only as part of the medical expense tax credit. While this can lower the total amount of taxes you owe, it’s not a deduction that reduces your total taxable income.
When are life insurance premiums considered tax deductible?
While most Canadians can’t deduct life insurance premiums, there are exceptions to the rule, and primarily related to businesses. For example, a part of your premium may be tax deductible if you use your life insurance policy as collateral for a business-related loan.
It’s important to note that the tax deduction for life insurance premiums applies to a very specific set of circumstances. If you think it applies to you, it’s best to speak with a qualified tax professional who can provide guidance and help you avoid any issues come tax season.
Can self-employed individuals write off life insurance?
We’ve covered rules around life insurance tax deductions for individuals. But what if you own your own business?
The rules for tax deductions are a little different for self-employed Canadians. Business owners are usually eligible for a few additional deductions, such as business use of a home office or other business-related expenses. These are often referred to as write-offs.
When it comes to life insurance premiums though, most self-employed individuals cannot write off life insurance premiums. Speaking to a qualified tax professional is the best way to ensure you maximize your tax deductions and understand the rules that apply to you.
Are life insurance benefits taxable in Canada?
The good news is that while life insurance premiums aren’t tax-deductible, life insurance benefits generally also aren’t taxable, so long as they are paid out directly to the beneficiaries.
Like other financial gifts and cash inheritances, life insurance payouts aren’t considered gross income for tax purposes. This means your loved ones get the full value of your life insurance coverage without needing to worry about any tax implications. If you purchased a term life insurance policy for $500,000, your beneficiaries would receive the full $500,000 to cover debts, expenses, or financial obligations. Depending on your term life insurance rates and your coverage amount, the financial benefits of this tax-free lump sum likely far outweigh the value of any tax deductions from your premiums.
You’re probably wondering if there’s a caveat. Here it is: If you don’t name a beneficiary for your term life policy, you may indirectly pay taxes on the death benefit when it’s paid out to your estate.
Your estate is essentially everything you own at the time of your passing. Your estate, including your death benefit, is distributed to your spouse, children, or family members according to your will or the laws in your province after your passing. But your estate would be subject to estate taxes first, which can reduce the amount of money that is ultimately passed to your loved ones.
By naming a beneficiary (or multiple beneficiaries) in your life insurance policy, you can ensure your full life insurance payout goes directly to your loved ones. You can also prevent unnecessary delays during an already difficult time.
What about permanent life insurance policies? Unlike term life insurance policies, permanent life insurance policies come with additional tax implications if you withdraw any cash value, cancel the policy, or earn interest. It’s one of the reasons that term life insurance is a simpler and more flexible option for Canadians.
Does life insurance taxation differ by province?
Life insurance taxation is generally the same across Canada, whether we’re talking about sales tax, premiums, or payouts:
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