Are Life Insurance Proceeds Taxable to the Beneficiary in Ontario?

You have received a life insurance payment after a death, or you expect one, and you want to know whether the tax bill is coming. For most people the headline answer is reassuring, but there are some details that catch people out, especially once the money starts earning interest.

This article explains how death benefits are generally taxed, when growth or interest can be taxed, how other payments differ, and what to check if you receive government benefits. An accountant or lawyer can apply this to your situation.

The general rule: the death benefit is not taxed

Life insurance paid to a named beneficiary is described by the Financial Consumer Agency of Canada as a one-time, tax-free payment, and beneficiaries generally owe no income tax on the death benefit. The CRA's list of amounts that are not reported or taxed includes most amounts received from a life insurance policy after someone's death, and most gifts and inheritances.

The word most matters. The rule covers the death benefit itself. Other payments that arrive around the same time, such as employer benefits or amounts from registered plans, follow different rules, covered below.

When interest or investment growth is taxable

The CRA says income earned on non-taxed amounts is taxable. So if you receive the benefit and then put it in a savings account, a GIC or investments, the interest or growth you earn after you receive it is income you report. The original payment stays tax-free; the earnings do not.

Where the insurer holds the money for a time before paying and adds interest, the interest is a separate question from the death benefit. Whether it is taxable to you and how it will be reported is worth confirming with an accountant. Keep the insurer's payment letter and any tax slip you receive.

• The death benefit paid to you as a named beneficiary is generally not taxed.
• Interest or investment earnings on the money after you receive it are taxable.
• Keep a record of the date and amount received, so you can separate the benefit from later earnings.

Payments that are not the same as life insurance

Employer death benefits are different from life insurance. Up to $10,000 of the total of all employer death benefits received is exempt from tax, and amounts above that are generally taxable to the recipient. A CPP/QPP death benefit is not eligible for that exemption.

Registered plans are also different. For a RRIF, the annuitant is treated as having received the fair market value of the RRIF just before death, reported on the final return, unless a spouse or common-law partner becomes successor annuitant. A qualifying survivor can defer tax on a designated benefit by transferring it to certain registered plans, within the time limits. These are not life insurance, so do not assume the tax-free rule applies.

If the estate is the beneficiary, or the beneficiary is a child

If no one is named, the benefit defaults to the policyholder's estate. If the estate is the beneficiary, the death benefit is distributed under the will and can be subject to estate taxes and creditors' claims, while naming individuals keeps it away from both. Estates in Ontario that need a certificate also face estate administration tax: nothing on the first $50,000 of estate value, then $15 for every $1,000 (or part) above that. Whether a particular benefit adds to the value used for that tax depends on how it is paid, so ask a lawyer.

If a minor is the beneficiary and no trustee is named, amounts over $35,000 are paid into court or to a court-appointed guardian of property, while under $35,000 the money can go to the parent or lawful custodian, who holds it until the child turns 18. Tax on later earnings is a separate matter and an accountant can explain who reports it.

If you receive ODSP and what to do next

A tax-free payment can still affect benefits. ODSP asset limits are $40,000 for a single recipient and $50,000 for a couple. Inheritances or life insurance proceeds placed in trust for an ODSP member are exempt as an asset up to $100,000 combined with life insurance cash surrender value. Payments from trusts, life insurance and windfalls count toward the $10,000 gift and voluntary payment limit in a 12-month period, with exceptions for things like disability-related items. ODSP recipients must tell ODSP about any income or other money they or their family receive. Speak to a lawyer before accepting or spending a large payment.

• Keep the insurer's claim letter, payment confirmation and any tax slip.
• Check whether the payment is a life insurance death benefit or an employer or plan benefit.
• Record the date you received the money, and track interest or growth afterward.
• Report the interest or earnings on your return as your accountant advises.
• If you receive ODSP, report the payment and get advice before spending or moving it.
• If the estate was the beneficiary, ask the estate trustee how the benefit is being handled.

Frequently asked questions