Life insurance premiums are not normally deductible for income tax purposes because they are considered personal expenses. However, there are two scenarios under which the premiums are deductible.
First, if an employer pays life insurance premiums for an employee and the insurance is for the benefit of the employee or his or her family (e.g. the beneficiaries are the employee’s estate, or spouse or children), there is a taxable benefit for the employee. On the payment side, the employer can normally deduct the premiums as a business expense.
Second, there is a special rule in the Income Tax Act that allows a deduction if a taxpayer takes out life insurance and is required to assign the insurance policy to a financial institution as collateral for a loan. A deduction for the premiums is allowed, generally if the loan is used for the purpose of earning income from a business or property.
As an example, if you own a private corporation that needs a loan, your bank may require insurance on your life as collateral, particularly in the case where the corporation has few hard assets and its value is largely dependent upon your effort and expertise. If your corporation pays the premiums on the insurance, it can normally deduct the premiums.
However, the amount of the deduction is limited to the “net cost of insurance in respect of the year” under the policy. The net cost of insurance is determined using actuarial principles set out in the Income Tax Regulations. In general terms, it uses mortality assumptions and is meant to approximate the cost of the pure life insurance coverage under the policy for the taxation year.
The deduction is also limited to the amount that “can reasonably be considered to relate to the amount owing from time to time during the year” under the loan. For example, if the life insurance coverage under an assigned policy is $1 million and the amount owing under the loan throughout the taxation year is $400,000, the amount deductible is limited to 40% of the lesser of the premiums payable and the net cost of pure insurance under the policy for the year.
The CRA states that it is not necessary that the insurance policy be taken out at the time of borrowing. An assignment of an existing policy is acceptable for these purposes.