How Does Life Insurance Work in Canada?

Life insurance in Canada serves as a financial contract providing a tax-free, lump-sum payment to designated individuals or entities upon the insured person’s death. This arrangement offers a financial safety net, helping loved ones manage expenses and maintain their financial stability. Policyholders pay regular fees, known as premiums, to keep the coverage active. The purpose of life insurance is to mitigate the financial impact from a loss of income or to cover specific financial obligations.

Types of Life Insurance in Canada

Life insurance in Canada primarily categorizes into two main types: term life insurance and permanent life insurance. Each type offers distinct features tailored to different financial planning needs and life stages.

Term life insurance provides coverage for a specific period, such as 10, 20, or 30 years, or until a certain age. It is often considered a more affordable option initially. If the insured person dies within the specified term, beneficiaries receive the death benefit. If the term expires and the insured is still living, there is no payout unless renewed. Premiums generally remain fixed for the chosen term, but typically increase upon renewal to reflect the insured’s older age.

Permanent life insurance offers coverage for the insured’s entire lifetime, provided premiums continue to be paid. This type of policy usually comes with higher premiums than term life insurance, but these premiums are often guaranteed to remain level for life. Permanent policies can accumulate a cash value, which grows on a tax-deferred basis.

Within permanent life insurance, there are two common sub-types: Whole Life and Universal Life. Whole life insurance guarantees a fixed death benefit and premiums for the policy’s duration. It also includes a guaranteed cash value that grows predictably. Universal life insurance offers greater flexibility with premiums and the death benefit, and includes an investment component where cash value growth depends on chosen investment accounts.

Understanding Your Life Insurance Policy

A life insurance policy involves several key components that define its operation and benefits. The “insured” refers to the individual whose life is covered by the policy. The “policy owner” is the person or entity who holds the rights to the policy, including the ability to make changes or access its value. This individual might be different from the insured person.

The “beneficiary” is the person, people, or organization designated to receive the financial payout, known as the “death benefit,” when the insured person passes away. The death benefit, also referred to as the face amount, is the lump sum of money paid out by the insurer.

For permanent life insurance policies, “cash value” represents a savings component that accumulates over time. Policyholders can access this accumulated cash value during their lifetime through policy loans, withdrawals, or by surrendering the policy.

“Riders” or add-ons are optional enhancements that can be appended to a life insurance policy to provide additional coverage or benefits. These can customize a policy to address specific needs, such as a waiver of premium if the insured becomes disabled, or an accelerated death benefit for terminal illness. Riders typically increase the policy’s overall cost, but they can offer tailored protection.

Applying for Life Insurance in Canada

Obtaining a life insurance policy in Canada involves a structured process. Individuals typically engage with a licensed insurance agent or broker to discuss their needs and explore available policy options.

Applicants complete a detailed application form. This form requires comprehensive personal information, including health history, current medications, family medical history, lifestyle habits, and financial situation.

The application then proceeds to underwriting, where the insurance company assesses the risk. This assessment may involve a medical exam, including blood and urine tests, and a physical examination. Underwriters also review medical records and may conduct tele-interviews for more information.

Based on the underwriting assessment, the insurer determines eligibility and the appropriate premium rate. The company may issue a policy offer, which could be an approval at a standard rate, with a higher premium due to increased risk, or a decline. The final step involves policy issuance and acceptance, where the applicant reviews and formally accepts the terms. Coverage becomes active upon the first premium payment.

Policy Payouts and Tax Treatment in Canada

When an insured person passes away, beneficiaries initiate a claim by notifying the life insurance company. This involves submitting the death certificate and specific claim forms. Most death benefits are issued to beneficiaries within 30 to 60 days once all required documents are received and validated.

The death benefit paid out from a life insurance policy in Canada is generally received as a tax-free lump sum by the designated beneficiary. This applies whether the policy is term or permanent life insurance.

While the death benefit is tax-free, accessing the cash value component of a permanent life insurance policy during the insured’s lifetime can have tax implications. If withdrawals or loans from the cash value exceed the adjusted cost basis (ACB) of the policy, the excess amount may be considered a taxable gain. The ACB generally represents the total premiums paid into the policy, less the cost of insurance. Any taxable gain would be subject to the policyholder’s marginal tax rate.

Life insurance death benefits generally bypass probate if a named beneficiary is clearly designated. This means the funds are paid directly to the beneficiary, offering privacy and quicker access compared to assets processed through an estate. If the estate is named as the beneficiary, the death benefit becomes part of the estate and may be subject to probate fees and used to cover outstanding debts or taxes.