THE COMPLEXITY OF TAXATION OF LIFE INSURANCE

When it comes to tax regulations concerning life insurance, it is rather complicated. For ordinary people, it can be difficult to comprehend.

While some of the applicable taxes are told to the insured, others are kept hidden. As far as taxation of premiums is concerned, it is usually not explained to the client.

Each province in Canada applies taxes on the premiums of various individual insurance products such as disability insurance, critical illness insurance, or life insurance. These are collected directly by the insurance company which then remit to the provincial government without you ever knowing.

In this article, you will find out more about the aspects of this taxation system.

Read our article discussing in depth the topic of taxation of life insurance.

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What taxes are transparent in life insurance?

The tax rate for life insurance premiums is around 2% to 5%, depending on the province in Canada.
These taxes are applicable to the whole premium, that is to say, it also affects the savings portion of a life insurance policy, including the cash surrender value (permanent life insurance or universal), as well as any refund of premiums. No other financial product taxes savings.

Sales tax in Quebec

In addition to this tax on life and health insurance products, three Canadian provinces apply a premium tax on group insurance premiums. This is therefore added to the first tax mentioned earlier. In Quebec, the sales tax is 9%! To clarify, this means that the tax rate for a group insurance in Quebec is as high as 12.79% (tax on premiums at 3.48% + sales tax of 9%). Fortunately, individual insurance is not subject to the 9% sales tax.

At the end of February, the government of Saskatchewan recalled taxes applicable on personal and insurance products, retroactive to the date of commencement of the tax which is August 1 of last year. Other provinces would eventually consider following the example of Saskatchewan.

The income tax on the investment

Some things sometimes have names that can be misleading. Such is the case of exempt life insurance.

In reality, the income of a life insurance policy that is not exempt is taxable, as is interest income, depending on the policyholder’s level of taxation. With respect to exempt life insurance policy, it is taxed a MINIMUM of 15% , namely the income tax on the investment income to which the insurance company is subject.

This tax, imposed by the federal government, only applies to policies with a savings component. This one has many consequences.

This tax significantly reduces investment growth. It is, therefore, necessary to make adjustments to the premiums of the contract. The tax on investment income is generally included in the administrative costs related to the so-called universal life insurance or is integrated into the premiums of the contract so the premiums are invariable.

The provision of the contract

There has been some talk about the repercussions of buying back or transferring a life insurance policy. As a result, the tax implications are generally explained to clients in Quebec.

What are the consequences of your choice of life insurance product?

The tax implications greatly influence brokers in terms of life insurance products offered to their clients. That is why the question of whether the client has contributed to his RRSP, RRIF, TFSA, or RDSPs to the maximum and he or she is debt-free often comes up.

If all these conditions are not met, the cash value insurance is not advisable. However, if the client has maximized all of these savings products with significantly better tax incentives, universal life insurance can be considered.