Before structuring insurance, you need to understand how it’s taxed.

Whether you’re protecting a family, retaining earnings inside a corporation, or planning for estate liquidity, tax treatment determines whether a policy is efficient or expensive.

If you’re evaluating coverage:

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Now, let’s examine how insurance is actually taxed in Canada.

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1. Life Insurance Taxation in Canada

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1.1 Are Death Benefits Taxable?

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Under Canadian tax rules, life insurance death benefits are generally received tax-free by beneficiaries.

This applies to:

• Personally owned policies
• Corporate-owned policies (with additional implications discussed below)

The proceeds are not considered income and do not trigger income tax in the hands of the recipient.

However, insurance does not eliminate other taxes triggered at death — such as deemed disposition of capital property. It may simply provide liquidity to fund them.

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1.2 Are Life Insurance Premiums Deductible?

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In most cases:

• Personal life insurance premiums are not deductible.
• Corporate-owned policy premiums are generally not deductible.

A limited exception may apply where a policy is required as collateral for a loan used to earn business or property income. Even then, deductibility is restricted and technical.

Life insurance is not designed to create current tax deductions. Its tax advantage lies in the treatment of the benefit.

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2. Permanent Life Insurance: Tax-Deferred Growth and Adjusted Cost Basis (ACB)

Permanent policies (e.g., whole life, universal life) include an accumulating cash value component.

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2.1 Tax-Deferred Growth

Growth within the policy is not taxed annually, provided the policy qualifies as an “exempt policy” under Canadian tax rules.

This tax-deferred compounding is often cited as a planning advantage — but it must be evaluated relative to:

• TFSA (tax-free growth)
• RRSP (tax-deferred with deduction)
• Corporate passive investment structures

Permanent insurance is typically considered only after registered accounts are optimized.

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2.2 Adjusted Cost Basis (ACB) Erosion

The Adjusted Cost Basis (ACB) of a life insurance policy declines over time due to the Net Cost of Pure Insurance (NCPI).

This is critical because:

• If the policy is surrendered, tax is payable on the excess of cash value over ACB.
• As ACB declines, taxable exposure on surrender can increase.
  
  

For corporately owned policies, ACB erosion also impacts Capital Dividend Account (CDA) planning at death.

3. Corporate-Owned Life Insurance and the Capital Dividend Account (CDA)

When a corporation is the beneficiary of a life insurance policy:

• The death benefit is received tax-free by the corporation.
• The corporation’s Capital Dividend Account (CDA) is credited by the death benefit minus the policy’s ACB.

The CDA can then be distributed to shareholders as a tax-free capital dividend.

This structure is often used to:

• Offset corporate-level tax on deemed disposition of shares at death.
• Provide liquidity to redeem shares from an estate.
• Equalize inheritances among beneficiaries.

However:

• Premiums remain non-deductible.
• Investment comparison must account for opportunity cost.
• Policy structure must align with long-term shareholder objectives.

Permanent corporate-owned insurance is an estate liquidity tool — not a generic tax shelter.

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4. Critical Illness Insurance: Tax Treatment

Critical illness (CI) insurance typically pays a lump sum upon diagnosis of a covered condition.

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4.1 Personal Ownership

• Premiums are paid with after-tax dollars.
• Benefits are generally received tax-free.

The tax efficiency lies entirely in the benefit being non-taxable.

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4.2 Corporate Ownership

Where a corporation owns the policy:

• Premiums are generally not deductible.
• Benefits are typically received tax-free by the corporation.

However:

• CI proceeds do not create a CDA credit.
• Subsequent distribution to shareholders may be taxable unless structured carefully.

For incorporated professionals, CI is less about tax arbitrage and more about protecting retained earnings and preventing forced distributions or asset sales during recovery.

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If your income or business continuity depends on you:

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Understanding cost is the first step before structuring ownership properly.

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5. Disability Insurance: The Tax Trade-Off

Disability insurance is structurally different from life and CI insurance.

Taxation depends on who pays the premium.

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5.1 Premiums Paid Personally

• Premiums are not deductible.
• Benefits are generally received tax-free.

This is often preferred for incorporated professionals who want tax-free replacement income.

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5.2 Premiums Paid by Corporation

• Premiums may be deductible to the corporation (if structured correctly).
• Benefits received are taxable income.
  
  

The trade-off is clear:

Deduction today vs. taxable benefits later.

For high-income professionals, paying premiums personally often results in superior after-tax outcomes.

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6. Families vs Incorporated Professionals: Tax Alignment

The appropriate insurance structure depends on risk exposure and income structure.

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For families:

The goal is tax-free protection during peak liability years.

If you have dependents and want to see what coverage would cost:

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For incorporated professionals:

The goal is preventing business disruption and preserving long-term tax strategy.

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7. Common Technical Misconceptions

“Permanent insurance eliminates estate tax.”
No. It provides liquidity to pay tax triggered by deemed disposition.

“Corporate ownership makes premiums deductible.”
Generally incorrect.

“Critical illness creates a CDA credit.”
It does not.

“Insurance is an investment alternative.”
It is primarily a risk-transfer mechanism with specific tax characteristics.

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Final Perspective

In Canada, insurance planning is less about deductions and more about:

• Tax-free benefits
• Liquidity at death
• Corporate distribution mechanics
• Ownership structure

The wrong structure can create unnecessary tax friction.
The right structure can preserve stability — both personally and corporately.

Before structuring ownership, confirm what level of coverage you actually need.

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Start there:

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Clarity first. Structure second. Tax efficiency follows.

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