While some types of life insurance can be complex, the way most policies work is actually pretty simple.
3 Things to Know About How Life Insurance Works
You buy coverage to protect your family in case you pass away.
In exchange for a fee that you typically pay monthly or annually (your insurance premium), an insurance company provides a certain amount of coverage—for a specific amount of time—on your life. (You can select the amount of coverage you want when applying for a policy.)
If you were to pass away while you have coverage, your beneficiaries would be able to make a claim and receive a death benefit equal to the amount of coverage you purchased. Learn how certain types of life insurance can protect you for a short period of time or for your entire life.
Your family will receive the death benefit tax free.
One of the great things about the life insurance death benefit is that it’s not usually taxable—whether your policy pays out $50,000 or $500,000. This means your beneficiary will receive the full amount and won’t have to report the amount as taxable income on their Canadian tax return.
A word of caution, however. If you don’t name a beneficiary on your policy, your “estate” will be designated as the beneficiary. If this happens, then the death benefit could be reduced by probate fees, also known as the estate administration tax. (Your “estate” is essentially all of your assets and liabilities at the time of your death.)
Another example of when life insurance might be taxable is if you have a whole life insurance or universal life insurance policy that accumulates cash value. Check out The Types of Life Insurance Explained to learn more about cash value life insurance. To read more about taxes and life insurance, check out Is a Life Insurance Payout Taxable?
Your family can use the death benefit for anything.
Your beneficiaries are free to use the death benefit as they wish. For example, they can use the money to:
- Take care of childcare expenses and household bills
- Pay off or pay down your mortgage
- Settle other debts, like credit card bills and car loans
- Send your kids to college or university
- Cover your funeral and other final expenses