Life insurance policies are distinct from most other capital property: the death benefit from an exempt policy is not subject to capital gains tax and is excluded from income.
However, the insured's death triggers a deemed disposition of all other capital property the insured owned, including real estate, investments, shares of private corporations, and RRSPs (deemed to be received by the surviving spouse or common-law partner in a tax-deferred rollover, or fully included in the deceased's terminal return if no rollover is available).
Life insurance is frequently used in estate planning to:
- Fund the capital gains tax liability triggered on the deemed disposition of appreciated capital property (a farm, a vacation home, a private company).
- Equalize an estate where one heir receives an illiquid asset and others receive cash equivalents.
- Fund a buy-sell agreement at the death of a shareholder in a closely-held corporation.
Key relationship: life insurance proceeds (tax-free) can offset tax liabilities triggered by deemed dispositions (taxable) at death, making insurance a planning tool rather than a pure protection product in many business and estate contexts.
Recall: Does the deemed disposition rule apply to life insurance proceeds? What other assets trigger a deemed disposition at death?