Personal Insurance Needs


Many life changes cause different needs for life insurance. This Tax Topic will focus on life insurance funding for family and estate needs upon an individual’s death.

Note: these tax topics are distributed on the understanding that neither nor Manulife Financial is engaged in rendering legal and accounting advice.

Last updated March 2012

Funding Needs at Death

In general, one of the greatest benefits of life insurance is that it provides a tax-free lump sum payment upon the death of the individual who is insured. A life insurance policy beneficiary designation enables the proceeds to be paid directly to the party indicated by the policyholder on the death of the individual insured. In the personal context, life insurance is generally used to provide protection for surviving dependants, to preserve, create, increase the value of or replace an estate and to provide funds required to bring about an equitable distribution of an estate.

Protecting Dependents

Life insurance proceeds received on the death of an individual can provide funding for the maintenance of the deceased’s dependents. The proceeds can replace the deceased’s earnings, pay debts and other liabilities, or cover education costs and daily living expenses of dependents.

In the case of separated or divorced parties a court order may require that insurance be in place to continue to support the dependent(s) after the death of the individual. A full discussion of these obligations can be found in the Tax Topic Planning for the Inevitable: Divorce and Estate Planning.

To ensure that death benefit proceeds are received at an appropriate time or circumstance for the beneficiary, the policy owner may direct a Trustee as to how distribution of the proceeds should occur. This is particularly useful in situations where intended beneficiaries are minors, mentally incompetent or incapable of prudently managing their own financial affairs. For a discussion of planning with insurance trusts see the Tax Topic “Insurance Trusts”.

Normally, death benefits are received in one tax-free lump sum payment. However, insurance contracts may also provide a number of settlement options. For example, the contract may allow a policyholder or the beneficiary to choose to have the insurance proceeds purchase an annuity for the beneficiary or beneficiaries. This would allow for the payment of the death benefit in installments over a period of time.

Estate Preservation

Life insurance proceeds may be used to pay down debts, tax liabilities and other estate costs so that estate assets do not have to be eroded, liquidated or borrowed against in order to pay for these expenses. The following funding needs are discussed in more detail below: capital gains tax liabilities, tax liabilities associated with registered plans, estate tax liabilities and estate costs including probate, estate creation or capital replacement.

  1. Capital Gains Taxes
    Subsection 70(5)(a) of the Income Tax Act (ITA) provides that a deceased taxpayer is deemed to have disposed of each capital property owned by him or her, immediately before death, for proceeds equal to the fair market value at that time. Capital property includes depreciable and nondepreciable property. Shares of a corporation, partnership interests, mutual or segregated fund units, and cottage properties and land are common examples of non-depreciable capital property. Common examples of depreciable capital property include machinery, buildings and business vehicles.
    At death, a capital gain will be realized for tax purposes to the extent that the fair market value exceeds the deceased’s adjusted cost base (ACB) of the property. Subsection 38(a) of the ITA includes an amount equal to 50% of this gain in the deceased’s terminal income tax return. The deceased may utilize any remaining capital gains exemption if the property consists of “qualified small business corporation shares” or “qualified farm property” each respectively defined under s. 110.6(1) of the ITA. Any taxable capital gains that are not sheltered by the capital gains exemption will be subject to tax in the deceased’s terminal return.
    For tax purposes subsection 70(5)(b) of the ITA provides that the deceased’s estate is deemed to have acquired the property at fair market value and accordingly this becomes the estate’s ACB of the property.
    In addition, for depreciable capital property, the deceased taxpayer may have to include recapture of capital cost allowance (CCA) on the terminal income tax return. Recapture is equal to the amount by which the lesser of capital cost and fair market value of the property immediately before death exceeds the undepreciated capital cost (UCC) of the property. Such amounts are fully taxable as regular income.
    Life insurance may be purchased to provide the funds necessary to pay the tax liability resulting from capital gains and recaptured depreciation triggered upon the death of the individual. Life insurance will be particularly important as a funding vehicle if the beneficiaries wish to retain the property or if market conditions will not provide the estate with an amount equal to the fair market value of the property.
    Taxation at death may be deferred if a spouse (or common-law partner) or a qualifying spouse trust receives capital property of the deceased. Under subsection 70(6) of the ITA, the property will be deemed to have been transferred at proceeds of disposition equal to the ACB (the capital cost and UCC in the case of depreciable capital property) of the property. As a result, the taxpayer would realize no capital gain or loss in the year of death. Any capital gains (or recapture of CCA) are postponed until the spouse or qualifying spouse trust disposes of the property. A qualifying spouse trust is defined under subsection 70(6)(b) of the ITA as a trust where only the surviving spouse or common-law partner is entitled to its income and has access to its capital until the surviving spouse’s death.
    Where a rollover is available the tax liability will result on the death of the surviving spouse. Therefore the funding need is postponed until that time. Joint second-to-die life insurance may be used to fund the tax liability resulting from the capital gains and recaptured depreciation triggered upon the death of the survivor spouse.
  2. Registered Plans Tax Liabilities
    At death, a taxpayer is deemed to have disposed of registered retirement savings plans (RRSP) and registered retirement income funds (RRIF) for proceeds equal to their fair market value pursuant to subsections 146(8.8) and 146.3(6) of the ITA, respectively. This is included as regular income and is fully taxable in the year of death. A rollover to a spouse’s or common-law partner’s RRSP or RRIF is permitted by subsection 60(l) of the ITA. Similar to the capital gains tax liability, life insurance may be purchased to fund the tax liability associated with bringing registered funds into income on the first or second (of two spouses’) death.
  3. Estate Taxes
    A deceased person may be liable for estate taxes in other jurisdictions. For example, the United States imposes estate taxes, (income and gift taxes) on its citizens’ worldwide assets, no matter where they reside. For a further discussion on this topic see the Tax Topic “U.S. Estate Taxes”.
    Careful planning should take place when estate taxes in another jurisdiction are at issue. Insurance can be used to address estate taxes in other jurisdictions, such as the United States but there may be some limitations to the planning that can occur. The laws of that jurisdiction should be reviewed and a professional advisor(s) in the foreign jurisdiction consulted to ensure appropriate planning occurs.
  4. Probate Fees and Other Estate Costs
    Life insurance can provide the necessary funding for estimated probate costs in addition to other estate costs. Other estate costs could include, burial and funeral arrangement expenses, estate administration costs (e.g. executor’s fees, valuator or appraiser fees) and legal and accounting fees.
    Probate (now referred to as a tax in some jurisdictions) validates a deceased's will and confirms the appointment of the executor(s) by confirmation of the court. The fees or tax are based on the value of the estate and vary from province to province depending upon how the value is determined in applicable provincial legislation. Ontario and British Columbia currently have the highest probate fees in the country while Alberta has capped its probate fees and Quebec has virtually no fee. The estate may be liable for probate fees in more than one province. There is no mechanism to credit fees paid in one jurisdiction against fees owing in another jurisdiction.
    A named beneficiary in a life insurance policy and/or annuity contract is one method of planning that can be used to avoid probate fees. Life insurance proceeds are paid directly to the named beneficiary and do not form part of the assets of the estate for valuation purposes. The proceeds are therefore not calculated in the assets of the estate to determine the value. This planning obviously does not work if the estate of the insured is named as the beneficiary under the policy.
  5. Create, Increase or Replenish an Estate
    It may be difficult to accumulate sufficient assets desired to pass on to beneficiaries. The death benefit proceeds from an exempt life insurance policy are received tax-free to the beneficiary on death. Thus life insurance can be an efficient means to create an estate or to pass on wealth to the next generations. By investing funds that would normally be subject to annual accrual taxation into an exempt policy, more funds may be provided to heirs than would have otherwise been the case.
    Life insurance is often used to replenish an estate. Debt of the estate may erode what would otherwise be available to beneficiaries. By having life insurance proceeds available to pay the debt, the estate is left fully in tact for beneficiaries to receive their share.
    During life an individual may donate property to a charity. The donor would benefit from the tax credits available in respect of such a donation. To ensure that the estate is not depleted by such gifts, life insurance is often purchased to replace the capital, which was conveyed to the charity.
    Another instance in which capital replacement is the goal is where the individual utilizes the insured annuity concept. In this concept, a prescribed annuity (defined under Regulation 304 of the ITA) is purchased in combination with a life insurance policy. The strategy is commonly employed when the individual desires to maximize income during life and preserve capital at death. A prescribed annuity contract is not subject to annual accrual taxation. Instead subsection 56(1)(d) and 60(a) of the ITA provide that a blended payment of capital and income in the same ratio for the term of the 4 contract is received. This averages out the amount subject to tax and results in more favourable current tax treatment due to an element of tax deferral. However, the purchase of the annuity uses up capital and therefore a life insurance policy is purchased to replace capital. See the Tax Topic on “Insured Annuities” for a lengthier discussion.
    Another common use for life insurance is to facilitate the equal or equitable distribution of an estate amongst beneficiaries. A common example is where an estate includes shares of a family business which will be distributed to the family members who are active in the business. Often the business represents the major asset of the estate and the value of the remainder that will be divided among the other family members who are not part of the business is significantly less. Life insurance may provide a lump sum to non-active family members to ensure an equitable or fair inheritance.

Creditor Protection

During the life of the insured under a life insurance policy, there is the potential for protection of the policy from the owner’s creditors. In the common law provinces, provincial legislation provides that if a beneficiary designation is made in favour of a spouse (depending on the province “spouse” may include a common-law or same-sex partner), child, grandchild or parent of the life insured under the policy, the policy will be exempt from seizure by the owner’s creditors. In Quebec, it is the relationship between the owner and the beneficiary that is relevant. The class includes ascendants and descendants of the owner.
If a beneficiary is named irrevocably, the policy will be exempt from seizure by the insured’s creditors. Where there is a named beneficiary, other than the estate, the death benefit passes directly to the named beneficiary and is not subject to creditors of the insured.

Withdrawals, Policy Loans and Leveraging

Once a significant cash value has been built up within an exempt policy, it may be utilized to supplement the owner’s retirement income or provide funding for a shortfall experienced during a period of disability.
The cash values within the policy may be accessed directly by way of a withdrawal or policy loan. These transactions would be considered dispositions of the policy and potentially subject to taxation. In respect of withdrawals, the policy’s adjusted cost basis (ACB) will be allocated proportionate to the ratio that the withdrawal is of the accumulating fund. In respect of policy loans, it is the entire ACB of the policy that is available. Even where a withdrawal or policy loan is subject to taxation either in whole or in part, there still may be a tax advantage to investing in life insurance. It may be possible to accumulate more in an exempt life insurance policy than would have been possible had the same funds been invested in a traditional investment that is subject to annual taxation. Moving the savings from a tax-exposed environment to a tax-sheltered environment may maximize the growth on the savings. It is for this reason that this strategy can make a great deal of economic sense.
Leveraging an exempt life insurance policy, which has accumulated sufficient cash values is another method of accessing the tax-free growth within the policy. A collateral assignment of a policy is not a disposition of the policy for tax purposes.

Collateral Insurance

Another life insurance application is collateral insurance where: when an individual makes loan arrangements the lender may require that the borrower provide life insurance as collateral security for the loan. The borrower would be the life insured under the policy. Should the borrower die, the lender would be assured of the quick repayment of the debt that is secured by the policy. Where a separate policy is purchased for this purpose a collateral assignment of the policy is required. The borrower would own such a policy and the borrower would have the right to name a beneficiary. A collateral assignment of a separate policy assures that the death benefit proceeds are used first to repay the creditor and any remaining amount would be paid to the designated beneficiary.
Depending upon the use of the funds, the life insurance premium may be deductible for tax purposes (the potential deduction is the lesser of the net cost of pure insurance (NCPI) or the premium paid).

Intergenerational Transfer of Life Insurance

Certain transfers of a life insurance policy will not be subject to taxation. A life insurance policy, therefore, may be a vehicle for transferring accumulated wealth to the next or succeeding generations on an inter vivos basis.
Subsection 148(8) of the ITA allows for a tax-free transfer of an interest in a life insurance policy to a child under certain conditions. Where this subsection applies the transfer takes place for proceeds equal to the policy’s adjusted cost basis (ACB). The transferor will be deemed to have disposed of interest in the policy at the ACB and the transferee will be deemed to have acquired the interest in the policy at a cost equal to the same ACB.
To qualify for the rollover, the interest in the policy must be transferred for no consideration to the policyholder’s child and a child of the policyholder or a child of the transferee must be the life insured under the policy. For the purposes of the rollover, the definition of child includes grandchild, great grand-child, a spouse of a child, a child of the person’s spouse or an individual under 19 years of age who is wholly dependent on the policyholder for support and is in the custody of the policyholder for the relevant time.
The transfer must not be made under the terms of the Will of the parent or grandparent. In such a case, the policy would be transferred from the parent or grandparent to the estate and then from the estate to the child or grandchild and would not qualify for the rollover. Subsection 148(8) of the ITA does not contemplate a transfer of the policy at death. In technical interpretation 9433865 dated February 15, 1995, Revenue Canada (now Canada Revenue Agency “CRA”) indicates that in order to qualify for the rollover the transfer must be made inter vivos or by way of a successor owner designation in order to prevent the policy from passing to the estate and thereby giving rise to a taxable disposition. For an in depth discussion on intergenerational transfers see the Tax Topics “Transfers of Personally Owned Life Insurance”.
It should be noted that a tax-free rollover of a policy to a spouse at death is also available pursuant to subsection 148(8.2) of the ITA. In order for the rollover to apply, both the policyholder and the spouse or common-law partner (or former spouse or common-law partner) must be resident in Canada. The provisions deem that the interest is disposed of for proceeds of the disposition equal to the adjusted cost basis to the policyholder immediately before the transfer, and the spouse, common-law partner, former spouse or former common-law partner acquires the policy at adjusted cost basis equal to those proceeds.

Other Personal Insurance Strategies

Life insurance may be purchased by an inter vivos family trust for the benefit of trust beneficiaries. The benefits of having the family trust invest in a life insurance policy are that the 21 year deemed disposition rule does not apply. Also, no annual income is allocated to the beneficiaries and the trust may be able to deduct the premiums from the trust’s income as an expenditure made on behalf of the beneficiaries. The Tax Topics “Trusts Just the Basics” and “Trusts as a Planning Tool” discuss planning with trusts and life insurance.

Often, split dollar arrangements are used in the personal insurance context to benefit two or more family members. The individuals jointly purchase a policy and enter into a formal split agreement. One party may have a need for a permanent level amount of insurance to fund a death benefit need and the other party may have a need for a tax-efficient investment vehicle. Each party would pay a portion of the premium for the benefit that they receive.


Life insurance can serve many purposes in the personal needs context. Traditional needs for life insurance proceeds include protecting dependents, preserving the estate, paying debts, tax liabilities and other estate costs. Life insurance can also be used to create, increase or replenish an estate or to equalize the estate amongst beneficiaries. Life insurance can meet various needs throughout an individual’s lifetime, as their particular needs change.

Appendix A

Registered Plans and Treatment on Death

Registered Retirement Savings Plans (RRSPs) and Registered Retirement Income Funds (RRIFs) are tax-advantaged savings plans designed to allow individuals to save for their retirement years. As it is assumed the reader has sufficient knowledge of the basics of RRSPs and RRIFs, this article will only address the issues that arise on the death of the annuitant.

When funds were first deposited into the RRSP or RRIF, the contributor received a tax deduction for that amount. For this reason, the tax rules provide that, when funds are withdrawn from the RRSP or RRIF, the annuitant is subject to tax on those amounts. The Income Tax Act also imposes a liability on the death of an individual. The general rule is that an individual is considered to have disposed of all assets upon his death. With regards to RRSPs and RRIFs, this means that the fair market value of the registered plan at the time of death is included in the annuitant’s final income tax return. A beneficiary will not have to pay tax on any amount received out of the RRSP if the amount of the plan is included in the deceased annuitant’s income. However, there are a number of exceptions provided in the Act to allow for transfers of the registered funds to spouses and certain dependents. These exceptions allow for the continuing tax-deferred treatment of the registered plan. Note that the definition of spouse now includes a common-law partner. In this article, the term “spouse” will be used to include both.

Death of an RRSP Annuitant

Under subsection 146(8.8) of the Income Tax Act (“the Act”), where a person other than the spouse is entitled to the proceeds of the plan, an annuitant is deemed to receive, immediately before his death, an amount out of the RRSP equal to the fair market value of the plan, less an amount that would be receivable by a surviving spouse if the plan had matured.

Subsection 146(8.9) provides a deduction to the deceased annuitant if an amount is paid out as a “refund of premiums”. The formula is fairly complicated, but essentially provides that the annuitant can deduct an amount, up to the amount included in income, for RRSP proceeds transferred to a spouse or a financially dependent child or grandchild of the deceased annuitant (a qualified beneficiary).

The definition of “refund of premiums” is found in subsection 146(1) and generally includes any amount paid out of the RRSP to a spouse or financially dependent child or grandchild where the annuitant died before maturity of the plan and the amount was paid as a consequence of the death.

Administratively, if the spouse is the sole beneficiary of the RRSP, the deceased is not considered to have received an amount from an RRSP if the following conditions are met:

  • The spouse is named as sole beneficiary in the RRSP contract; and
  • The spouse instructs the RRSP issuer to transfer, before December 31 of the year after the year of death, all of the RRSP property to another RRSP or a RRIF or an eligible annuity.

If these conditions are met, the spouse will receive an income inclusion (on a T4RSP) and will also receive an RRSP receipt for the amount transferred.

When a qualified beneficiary includes a refund of premiums in income, the beneficiary can defer tax by transferring it to an eligible plan or fund. The deduction is found under paragraph 60(l). The following chart shows the eligible transfers:

Refund of premiums paid to: Can be transferred to
RRSP* RRIF Annuity***
• The annuitant’s spouse Yes  Yes Yes
• the annuitant’s financially
  dependent child or
  grandchild who:
  • was dependent because
    of a physical or mental
Yes Yes Yes
  • was NOT dependent
     because of a physical
     or mental infirmity

* The qualified beneficiary must be 69 years of age or younger at the end of year the transfer is made.

** A term certain annuity to age 18 is purchased. The maximum term is calculated as 18 minus the child’s age at the time the annuity is purchased (the term could be less than this if desired. The payments from the annuity have to begin no later than one year after the date of purchase.

*** There are two basic types of annuities described in subparagraph 60(l)(ii). The first is a life annuity or an annuity payable to age 90. This is only available to a spouse or a child/grandchild who is dependent by reason of physical or mental infirmity. The second is a term to 18 annuity as described above. This type of annuity is the only option for a dependent child/grandchild who is not dependent by reason of physical or mental infirmity. Proposed legislation (December 20, 2002) will allow a trust to be named as the annuitant under a life annuity or annuity payable to age 90 if the individual is physically or mentally infirm. Existing provision already allow a trust to be names as the annuitant under a term to 18 annuity. This will allow the trustee to retain control of the funds for an individual who is physically or mentally infirm and yet still obtain the tax deferral.

The transfer or purchase must be completed in the year the refund of premiums is received or within 60 days after the end of the year.

The definition of “financially dependent” generally requires that the individual not have income in excess of the basic threshold amount (found in paragraph 118(1)(c)). In certain cases, the individual could apply to CRA to determine that they are still financially dependent even though income was higher than the threshold amount. The February 18, 2003 federal budget has proposed to increase the threshold amount for infirm children and grandchildren by adding $6,180 to the basic threshold. Therefore, the amount at which an infirm child or grandchild can be considered financially dependent has been raised to $13,814 (indexed after 2003).

“Tax paid amount” is also defined in subsection 146(1) and generally means any amounts in the RRSP that are subject to tax in the hands of someone other than the annuitant.

Under 146(8.1), an amount can be still considered a refund of premiums even if paid to the annuitant’s estate if:

  • A qualified beneficiary is a beneficiary of the annuitant’s estate and;
  • The annuitant’s legal representative and qualified beneficiary jointly file Form T2019, “Death of an RRSP Annuitant – Refund of Premiums” to designate all or part of the amounts paid as a refund of premiums.

When an RRSP annuitant dies, the funds are generally not immediately paid out of the plan, and investment income often continues to accrue while the estate is sorted out. The taxation of income earned in the plan after death until December 31 of the year after the year of death depends on the status of the plan and the beneficiary. A detailed discussion of this treatment is beyond the scope of this article; however, the CCRA guide “RC4177 ‘Death of an RRSP Annuitant’ “ provides a good overview. If an RRSP is not collapsed before December 31 of the year after the year of death, it becomes taxable (ie the investment income becomes taxable to the beneficiaries).

Matured RRSP

A matured RRSP is an RRSP that has started to pay a retirement income (similar to a RRIF). The same general rule applies on the death of the annuitant and this requires that the fair market value of the plan be included in the deceased’s income. However, if the spouse is the sole beneficiary of the plan, the spouse becomes the successor annuitant (under the definition of 9 “annuitant” in subsection 146(1)) and no amounts are taxable to the deceased (subsection 146(8.8)). All payments made after the date of death become taxable to the successor annuitant (and all payments made up to the date of death are included in the deceased’s income). Also, if no beneficiary is named, but the will states that the spouse is entitled to receive amounts under the RRSP, the spouse can elect in writing, jointly with the legal representative, to become the successor annuitant (subsection 146(8.91)).

If the beneficiary of the matured RRSP is someone other than the spouse, the plan must be commuted to a lump-sum (paragraph 146(2)(c.2)). The amount is included in the deceased annuitant’s final income but it can be reduced where a “refund of premiums” is paid to a financially dependent child or grandchild.

Death of a RRIF Annuitant

The rules governing RRIFs are found in section 146.3 of the Act and the rules regarding treatment on death generally parallel that of RRSPs. The definition of “annuitant” in subsection 146.3(1) includes the original annuitant and the surviving spouse. This section provides that the carrier can make payments to the deceased annuitant’s surviving spouse provided that an election was made. This election is usually done in the contract and can be made at any time. It can also be made through the annuitant’s will. When the election is made, the surviving spouse becomes the annuitant under the fund and the payments continue to be made to the surviving spouse. Finally, the surviving spouse can also become the annuitant even if the first annuitant did not make an election – provided the carrier makes payments to the surviving spouse or common-law partner and the legal representative for the deceased annuitant consents. There can be another annuitant under a RRIF if the surviving spouse remarries and designates his/her new spouse as the annuitant under the plan on his/her death.

If the surviving spouse does not become the annuitant, the carrier must distribute the fair market value of the plan (i.e. collapse the RRIF) under paragraph 146.3(2)(d). The FMV of the plan is included in the deceased’s income on the final return (subsection 146.3(6)) unless a designated benefit is transferred to a surviving spouse or a dependent child or grandchild. In these cases, the plan must be transferred to an RRSP, RRIF or annuity – depending on the recipient. The chart found above in “Death of an RRSP Annuitant” showing eligible transfers under subsection 60(l) would also apply in the case of a RRIF. A “designated benefit” is defined under subsection 146.3(1) and is a distribution from a RRIF that would have been a “refund of premiums” had the plan been an unmatured RRSP. Thus, an amount paid to a surviving spouse or a financially dependent child or grandchild will be a designated benefit. This transfer can be made directly (ie if the spouse, child or grandchild is a beneficiary of the plan) or indirectly (through the will) by a joint election of the legal representative and the spouse, child or grandchild (on a Form T1090).

Administratively, the value of the RRIF is not included in the deceased’s income if the spouse is the sole beneficiary of the RRIF and if all the RRIF property is transferred to another RRSP, RRIF or eligible annuity by December 31 of the year after the year of death. If these conditions are met, the spouse will receive an income inclusion (on a T4RIF) and will also receive an RRSP receipt for the amount transferred.

Joint and Several Liability

The Act imposes joint and several liability on the taxpayer (the beneficiary) and the last annuitant (the deceased) with respect to amounts received from an RRSP or RRIF. Subsections 160.2(1) and (2) (for RRSPs and RRIFs respectively) provide a mechanism for CRA to obtain the tax owed on the RRSP or RRIF proceeds. This would occur, for example, where the proceeds of the RRSP are paid out to a non-financially dependent child such that the tax liability on the RRSP remains with the estate but the cash is now with the adult child. The taxpayer becomes jointly and severally liable for the portion of the deceased’s tax that is attributable to the RRSP or RRIF proceeds.

Canada Revenue Agency has produced two short guides that provide information on both these topics. The guides are: RC4177 “Death of an RRSP Annuitant” and RC 4178 “Death of a RRIF Annuitant” and they can be found at the local Taxation Office or at

* Please note:

  • the source material for these topics are various Manulife Financial articles, courtesy of Manulife Financial.
  • will strive to keep these articles updated and current.
  • these tax topics are distributed on the understanding that neither nor Manulife Financial is engaged in rendering legal and accounting advice.

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