Life Insurance Cash Out: What Canadians Need To Know

In Canada, permanent life insurance provides lifelong coverage and the opportunity to build cash value over time, which can be accessed during your life, with certain tax implications. Term life insurance, on the other hand, does not build any cash value and is temporary coverage that ends at age 85. Permanent life insurance, including participating and universal life insurance, offers the advantage of tax-free cash growth, allowing individuals to withdraw or borrow from their policy. However, it is generally more expensive than term life insurance. Understanding the differences between these options is crucial when considering cashing out life insurance in Canada.

Permanent life insurance

There are three types of permanent life insurance plans: whole life insurance, universal life insurance, and participating life insurance. Each plan comes with unique features to meet your specific needs. Here is how the two forms of permanent protection, universal and participating life insurance, compare:

Participating life insurance

• Guaranteed money grows inside your policy
• Conservative asset management
• Policyowner dividends
• Lifetime insurance coverage
• Guaranteed premium options

Universal life insurance

• Manage your risk and choose investment accounts
• Lifetime insurance coverage
• Guaranteed premium options

Term life insurance

Your premiums remain fixed and are guaranteed not to increase during the term of the policy. After the term ends, the policy will automatically renew annually until you turn 100, at which point coverage continues but premiums are no longer required.

In Canada, term life insurance is available to residents aged 18-70, with rates starting at less than $13/month.

Universal life insurance

You pay a premium for your insurance coverage, and after the insurance costs are covered, the remaining money goes to the policy's investment part. You can access the money in your account as long as there is enough left to cover the insurance costs. You can also choose who receives the money from your insurance protection when you die.

You can access the money you've earned in your policy by making a partial or full withdrawal, or by taking a policy loan. However, this may decrease your total death benefit. Withdrawing money from your policy may also have tax implications.

Participating life insurance

• Lifetime coverage: Participating life insurance provides guaranteed coverage for life, as long as the policy premiums are paid. The premiums remain the same throughout the premium-paying period, even as the policyholder ages or experiences health issues.
• Tax-free growth and payments: The cash value of the policy grows tax-free over time. Upon the death of the policyholder, their chosen beneficiaries receive a tax-free lump-sum payment.
• Access to cash: Policyholders can access the accumulated cash value of their policy at any time. This can be done through policy loans, withdrawals, or by pledging the cash value as collateral for a tax-free line of credit. However, accessing the cash value may affect coverage, and there may be tax implications.
• Policyowner dividends: Participating life insurance allows policyholders to "participate" in the insurance company's profits. The company assesses its profits annually and redistributes them to the policyholders. These dividends can be taken in cash, used to purchase additional insurance, or left to accumulate.
• Strong guarantees: Participating life insurance offers guaranteed premiums that won't change, a guaranteed death benefit, and a guaranteed growth in cash value over time.
• Flexibility: Policyholders have the flexibility to choose how to use their dividends. They can also decide who will receive the tax-free payment upon their death.

Tax-free cash value

Permanent life insurance policies, such as universal and whole life insurance, build up a cash value over time. This means that you can receive a cash payout if you cancel your policy before your death. However, the amount received will be less than the amount paid in premiums for the insurance costs.

The cash value of a life insurance policy can be accessed in several ways: borrowing from the policy, using it as collateral for a third-party loan, or withdrawing cash. Withdrawing from your policy may have tax implications. While your basis in the policy—the amount of premiums paid minus any prior dividends or withdrawals—is generally not taxed, the earnings from this basis are. This means that if you withdraw more than your basis, a portion of the withdrawal will be considered taxable income.

For example, if you have a cash value of $18,000 on your policy and a basis of $12,000, withdrawing $12,000 or less will have no tax consequences. However, withdrawing $15,000 will mean that you have to pay income tax on the remaining $3,000.

One way to avoid the tax and still access your money is to take out a policy loan from the insurance company, using the cash value in the policy as collateral. As long as you repay the loan, the amount borrowed is generally not treated as taxable income. However, you will have to pay interest on the loan, which is not tax-deductible.

Frequently asked questions