Jeffrey Wade
Life insurance is a contract between an insurer and a policyholder. In exchange for monthly payments, the life insurance company pays a death benefit to your beneficiaries when you pass away. The death benefit is a one-time, tax-free payment made to the beneficiaries of an insured person who has died. This payment is called a death benefit and is meant to financially support the policyholder's loved ones and relieve the financial burden of their passing.
| Characteristics | Values |
|---|---|
| Payment type | One-time, tax-free payment, also known as a death benefit |
| Payment amount | Depends on the amount of coverage purchased under the life insurance policy |
| Who receives the payment | Beneficiaries, usually a spouse or partner, children or other loved ones, but can also be a charity or other organisation |
| Number of beneficiaries | Can be more than one, in which case the payment is split according to dollar amount or percentage specified by the insured |
| Primary and contingent beneficiaries | Primary beneficiaries receive payment unless they have died, in which case contingent beneficiaries receive payment |
| Time taken for payment to be made | Within 30 days of receiving all claim requirements from the beneficiary |
| Reasons for non-payment | Lapse in coverage, cause of death not covered, false information on insurance application |
| Claim process | Beneficiary files a claim with the insurer, provides a completed claim form, copy of the death certificate, and policy number or copy of the policy |
What You'll Learn
Naming a beneficiary
A beneficiary is the person you name to receive your death benefit. You may name your spouse, another family member, a friend, a business partner, a trust, or a charitable organization as a beneficiary. You may also name more than one beneficiary for your life insurance policy. If you do, your insurance company will divide the death benefit among them. You may assign different proportions of your life insurance benefits to each beneficiary.
If you live in Quebec and name your spouse as your beneficiary, they are presumed to be an irrevocable beneficiary unless specified otherwise. You must check off the revocable box if you want to change this.
If your beneficiary is under the age of majority, you may want to set up a trust and designate a trustee or administrator. This person holds the amount of the death benefit in a trust on behalf of the minor. Without a trustee or administrator, the province or territory will hold the death benefit in a trust and pay your beneficiary when they reach the age of majority. Consult a lawyer or financial advisor for more details.
If you do not name a beneficiary, your money will go to your estate and may be subject to estate administration tax. It will also be available to any creditors of your estate.
It's important to name a beneficiary for each policy form when you purchase life insurance. If you don’t, your insurer will assume by default that your estate is the beneficiary.
You may want to consider naming an alternate or contingent beneficiary. This person or persons will receive the death benefit if your named beneficiary dies either before you or at the same time as you.
It's a good idea to review your beneficiary designations from time to time and update them if necessary.
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Claiming the benefit
In the event of the policyholder's death, the beneficiary must file a claim with the insurance company to notify them of the policyholder's passing. The beneficiary will be required to submit the following:
- A completed claim form
- A copy of the death certificate
- The policy number and other relevant documents, such as a copy of the policy
The funeral director can help the beneficiary obtain certified copies of the death certificate, which will be needed for various purposes beyond the life insurance claim, such as closing accounts and filing income taxes.
The beneficiary can usually download the claim form from the insurer's website. If the form is not available online, a company representative will be able to assist in obtaining it. The beneficiary must then complete the claim form and provide all the information requested by the insurance company.
The beneficiary will also need to decide how they want to receive the payout. Some insurance companies only offer a lump-sum payment, while others provide several options, including:
- Receiving the payout in instalments
- Converting the payout to an annuity
- Receiving payments for life or over a certain period
- Keeping the payout in an interest-bearing account
If there is more than one beneficiary, each may have to file a separate form. It is important to note that the payout amount is not taxable, but any interest earned on it is. Therefore, if the beneficiary is unsure about the best payout option, they should consult a financial advisor before making a decision, as they may not be able to change it later.
Once the beneficiary has submitted the completed paperwork and a certified copy of the death certificate, they will need to wait for the insurance company to process the claim. This can take anywhere from a few days to a few weeks, depending on the company's procedures and whether the policy is still within the contestability period.
The contestability period typically lasts for the first two years of a permanent life insurance policy and allows the insurance company to investigate the accuracy of the information provided during the application process if a claim is made during this time.
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How the benefit can be used
The benefit paid out by a life insurance policy in Canada can be used for anything the beneficiaries choose. However, it is primarily intended to provide financial support to the loved ones of the deceased and relieve the financial burden of their passing. This could include:
- Paying for final expenses, such as funeral costs
- Making mortgage payments
- Paying off other debts, such as credit card bills
- Childcare costs or education fees
- Daily living expenses
- Leaving a legacy for future generations or for a charity
- Replacing the lost income of the deceased
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Types of life insurance
There are two main types of life insurance in Canada: term life insurance and permanent life insurance. Term life insurance covers the insured for a specific period, typically ranging from 10 to 40 years, or until they reach a certain age, usually 65. Permanent life insurance, on the other hand, provides coverage for the insured's entire lifetime.
Term Life Insurance
Term life insurance is the most basic and affordable type of life insurance. It offers coverage for a specific term or period, making it ideal for those who want affordable life insurance for a set number of years. It is often chosen by individuals going through major life events, such as getting married, having children, or buying a home. Term life insurance can also help support financial dependents, pay school fees, or cover debts.
There are two main variants of term life insurance: traditional term life insurance and annual renewable term (ART) life insurance. Traditional term life insurance is the standard policy that lasts for a certain number of years and is the most popular and affordable type of coverage. ART life insurance, on the other hand, lasts for one year and is renewed annually, with premiums starting low but increasing over time.
Permanent Life Insurance
Permanent life insurance provides coverage for the insured's entire life as long as they continue to pay their premiums. It also usually includes a savings or investment component, allowing the policyholder to build cash value over time. This cash value can be accessed by the policyholder during their lifetime and will be paid out to the beneficiaries upon the insured's death.
There are several types of permanent life insurance policies, including:
- Whole life insurance: a type of permanent life insurance that provides coverage for the insured's entire life, with premiums remaining fixed. It often includes a guaranteed minimum cash value and allows the policyholder to access additional funds during their lifetime.
- Universal life insurance: combines life insurance with an investment account, allowing the insured to build wealth for their beneficiaries. It offers flexibility in terms of premium amounts and death benefit adjustments.
- Non-participating whole life insurance: includes an investment component that builds cash value over time but does not pay dividends.
- Participating whole life insurance: includes a cash value component and pays annual dividends to the policyholder.
- Term-to-100 life insurance: provides coverage for the rest of the insured's life but does not build cash value like other types of permanent coverage.
- Funeral or final expense insurance: designed to cover end-of-life expenses and funeral costs, and can also assist with estate planning.
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Tax implications
Life insurance payouts are generally not taxable in Canada. Death benefits made directly to named beneficiaries are tax-free, and beneficiaries don't need to report the money as additional income. However, there are some exceptions.
If you don't name a beneficiary, your estate will become the beneficiary by default, and the death benefit will be subject to estate taxes. Creditors can also claim it to pay off any outstanding debts.
Certain types of permanent life insurance have a cash value component that accumulates from the premiums you pay. This cash value grows based on a set formula or may be invested to earn interest. Taxes on this growth are deferred while the policy is in effect unless they exceed government limits. If you withdraw from the cash value or cancel your policy (known as "surrender") in exchange for the cash value, you may be subject to taxes or fees (known as a "surrender charge").
If your beneficiaries receive interest earnings from your policy, this will likely be taxed as income.
If you sell your permanent life insurance policy while you're still alive, the amount you receive in payment may be taxed as income. However, selling a life insurance policy is currently only legal in Quebec and was previously allowed in New Brunswick, Nova Scotia, and Saskatchewan.
If you have a life insurance policy that is paid for with after-tax dollars, the payout will be taxable to your beneficiaries.
Life insurance premiums are generally not tax-deductible in Canada. However, there are some exceptions, such as when the policy is used for business purposes or as collateral for a loan.
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Frequently asked questions
A life insurance payout is a tax-free lump sum paid to the policy's beneficiary when the insured person passes away. This is also called a "death benefit".
The life insurance payout process is straightforward in Canada. First, the beneficiary must file a claim with the insurer to let them know the insured person has passed away. This usually requires proof of death, like a death certificate. The beneficiary will then need to complete claim forms and submit any required documents, such as the death certificate and medical reports. After this, the claim will be reviewed by the insurance company, and if approved, the payout will be released.
Life insurance companies typically pay out the death benefit in a lump sum, but some offer other payment options as well. These include receiving the payout in instalments, as an annuity, or as life income with a certain period.
Yes, there are several factors that can affect the life insurance payout. These include the type of life insurance policy, policy exclusions, contestability periods, and the accuracy of information provided during the application process.
