How to calculate the taxable amount for a cashed-in whole life insurance policy
Featured writing by Allan Norman · M.Sc. · CFP · CIM
Cashing in a whole life policy often comes with an unwelcome surprise, a tax bill, and this piece walks through how that taxable amount is figured. Unlike capital gains, where only part of the gain is taxed, the calculation here is the cash surrender value minus the policy's adjusted cost base, with the whole difference taxable. The adjusted cost base is roughly the premiums paid less the underlying cost of the insurance, and because that cost climbs as you age, the base can shrink toward zero over the years, leaving much of the cash value exposed. It's most relevant to anyone considering surrendering an older whole life policy and wanting to know what they'll actually keep. The practical note worth carrying away is to ask the insurer for the numbers before cashing out, so the tax hit isn't a shock.
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Read on MoneySenseWhere this fits in your plan
The taxable amount is only one part of a bigger question. Before surrendering an older whole life policy, it may help to ask what job the policy was bought to do. Some policies were meant to leave money to a spouse or children, some to help cover tax at the second death, and some to support a business owner's estate. If that job still matters, keeping, reducing or cashing in the policy can each lead to a different picture, and the tax bill from a surrender may be only one number in the comparison.
In a planning scenario, we can place the policy next to your pension, RRSP or RRIF, and other assets, then compare what changes under each choice. The comparison may look different for a couple who own a corporation than for a couple who do not. Our insurance planning page explains how we show insurance inside the plan rather than apart from it. For a general overview of permanent life insurance, cash value and policy loans, see the Financial Consumer Agency of Canada's life insurance page, and ask your insurer for your policy's adjusted cost basis before deciding. This is general information, not personalized tax, legal or financial advice.
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