Life Insurance Cash Surrender: Taxable By Cra?

Life insurance is a significant investment, and understanding the tax implications of cashing out your policy is essential. The cash surrender value of a life insurance policy is the amount of money you receive if you terminate your policy before it matures or before your death. This value is separate from the death benefit and can be a useful source of funds for urgent expenses. However, it's important to note that cashing out your policy may result in tax consequences, depending on the amount you receive and the specifics of your policy. Understanding these tax implications is crucial for making informed decisions about your life insurance policy.

Surrendering a life insurance policy

Surrendering your policy means you will no longer have coverage and your beneficiaries will not receive a death benefit when you pass away.

When to Surrender Your Life Insurance Policy

There are several scenarios in which it may make sense to surrender your life insurance policy:

• You've found a better deal with another provider.
• You can no longer afford the premiums.
• You no longer need life insurance (e.g., no one depends on you financially).
• You need a large amount of cash quickly and don't have any other options.

How to Surrender Your Life Insurance Policy

If you decide to surrender your life insurance policy, follow these steps:

• Review your life insurance policy documents, including the contract, riders, amendments, and premium payment receipts. Look for information about cash surrender value, surrender charges, and other relevant terms.
• Contact your insurance provider's customer service to initiate the surrender process. They will guide you through the necessary steps.
• Fill out any required paperwork, such as a policy termination form or surrender request form. Provide all the requested information and documentation.
• Receive the cash surrender value from your insurer via check or direct deposit.
• Consult with a tax expert and financial advisor to ensure you properly report the payout and make informed decisions about saving or investing your funds.

Alternatives to Surrendering Your Policy

Before surrendering your life insurance policy, consider these alternatives that allow you to access your cash value while maintaining your coverage:

• Borrow against your cash value: You can take out a low-interest loan against your permanent life plan's cash value. Policy loans have no due date, but interest will accumulate on the outstanding loan balance.
• Withdraw from your cash value: Withdrawing from your cash value allows you to access your wealth without taking out a loan or surrendering your policy. However, withdrawals may trigger tax consequences if you withdraw investment gains, and they may reduce your death benefit.
• Use your cash value to pay premiums: Many permanent life insurance policies let you pay premiums with your cash value once you've accumulated enough. This can help reduce your life insurance costs while maintaining full coverage. However, if you drain your cash value, your policy may lapse.

Taxable income

The cash surrender value of a life insurance policy is generally taxable if it exceeds the amount paid in premiums. This is because the cash value is considered income by the government. In Canada, the cash surrender value is added as regular income in the same calendar year that the policy is terminated.

The tax implications of the cash surrender value depend on when and how the policyholder receives the cash value. If the cash surrender value is greater than the adjusted cost base (ACB) of the policy, it triggers a taxable income event. This is because the life insurance benefit, which is not taxable, has been collapsed, and so the gains on the policy must become taxable to the policyholder.

The cash surrender value is the total net amount of money a policyholder would receive on any given day if they were to terminate the policy contract. It is the total cash value minus any outstanding policy loans and minus any surrender charges, plus any premiums left in reserve. Surrender charges typically only apply to universal life policies and can remain in effect for 10 to 15 years.

If you receive more funds than the policy's cost basis, this may trigger tax consequences. Similarly, if you have outstanding policy loans that exceed the policy's cost basis, you will owe income tax on the lower surrender value if it exceeds the amount paid in premiums.

The cash surrender value of a life insurance policy is not always taxable. If you withdraw up to the amount of the total premiums you've paid, this is generally not taxed. However, if you withdraw any gains, such as dividends, these will be taxed as ordinary income.

It is important to consult with a tax expert to understand the tax implications of surrendering a life insurance policy and to report everything properly.

Tax consequences

The cash surrender value of a life insurance policy is generally not taxable in Canada. However, there are certain situations where you may have to pay taxes on the cash surrender value.

If you surrender your permanent life insurance policy, you will receive the cash surrender value, which is the total cash value minus any outstanding policy loans and surrender charges. This amount is typically paid in a lump sum, but some policies may pay it out in periodic payments.

The cash surrender value becomes taxable when it exceeds the adjusted cost base (ACB) of the policy. The ACB refers to the total amount of premiums you have paid into the policy. If the cash surrender value is greater than the ACB, the excess amount is considered taxable income and must be reported on your tax return.

It is important to note that the taxation of the cash surrender value of a permanent life insurance policy is more uncertain compared to the death benefit, which is generally tax-free for beneficiaries. While the death benefit is not taxable, the government can use it to cover any unpaid income tax from your estate, including investment earnings such as capital gains.

When you surrender your life insurance policy, you may also have outstanding policy loans that need to be considered for tax purposes. If the outstanding policy loans exceed the policy's cost basis, the insurance company will deduct the loan amount and interest from the cash surrender value. In this case, you will owe income tax on the lower surrender value if it exceeds the amount of premiums paid.

To avoid unexpected tax consequences, it is recommended to consult with a tax expert before surrendering your life insurance policy and receiving the cash surrender value. Additionally, you may want to explore alternative options to access your cash value, such as borrowing against the policy or using it to pay premiums, which may have different tax implications.

Cash surrender value calculation

Cash surrender value is the amount of money a life insurance policyholder receives for cancelling their policy before it matures or before they pass away. This is the savings component of most permanent life insurance policies, such as whole life and universal life. It is also known as the policyholder's equity.

The cash surrender value is the total cash value minus any outstanding policy loans, minus any surrender charges, plus any premiums left in reserve. Surrender charges are fees that insurance companies deduct before paying out the cash value. These charges can be as high as 10-35% of the policy cash value and typically apply during the first 10-15 years of the policy.

To calculate the cash surrender value of a life insurance policy, add up the total payments made to the insurance policy, then subtract the fees that will be charged by the insurance carrier for surrendering the policy. This will give you the total actual payout you would receive from surrendering the policy.

It's important to note that cash surrender value is different from cash value. Cash value is the amount of equity in a life insurance policy, which is built up through premium payments and grows over time. Cash surrender value, on the other hand, is the amount you receive when you cancel or "surrender" your policy.

In addition, the cash surrender value of a life insurance policy may be taxable. If you receive more than the policy's cost basis or adjusted cost base, you may owe income tax on the excess amount.

Permanent life insurance

Whole life insurance offers a guaranteed rate of growth for the cash value of the policy. It also has fixed premiums that never change, providing more certainty. Universal life insurance, on the other hand, offers more flexible premium options, and its earnings are based on market interest rates.

It's important to note that the cash surrender value of a permanent life insurance policy can be taxable in certain situations. For example, if the cash surrender value exceeds the adjusted cost base of the policy, it may be taxed as ordinary income.

In summary, permanent life insurance offers a combination of a death benefit and a savings component, providing ongoing coverage and financial flexibility. However, it comes at a higher cost compared to term life insurance.

Frequently asked questions