Tax Treatment of Life and Disability Benefits

By Kevin Wark, LLB, CLU, TEP, Chair of Tax Policy, CALU

March 2010

In February CALU consulted with the Department of Finance relating to the tax treatment of certain life and disability benefits payable under an exempt universal life policy. This was in response to recent correspondence with the Canada Revenue Agency (CRA) where the CRA suggested that the payment of certain disability benefits may result in a disposition of an interest in the policy. A summary of the CALU position is set out below.

Recently the tax treatment of certain life insurance and disability benefit payments provided under exempt life insurance policies has been the subject of review and discussion with the CRA. The payment of such benefits will result in a reduction to both the fund value and death benefit payable under the insurance policy.

The CRA initially expressed the view that a life benefit payable on first death under a joint last-to-die (JLTD) insurance policy may represent the disposition of an interest in an insurance policy or a policy loan, with potential adverse tax consequences to the policyholder. However, they subsequently agreed that such benefits would not result in the disposition of an interest in a life insurance policy. 

Similar concerns have been expressed by the CRA in respect to the payment of disability benefits (in the form of a disability income (DI), critical illness (CI) or long-term care benefit) under an exempt insurance policy, and to date it has not fully accepted the industry´s position that the payment of such benefits would not result in the disposition of an interest in a life insurance policy.

In both cases the CRA has indicated that the tax treatment of these benefits has been brought to the attention of Finance for its review and consideration. CALU is prepared to work with Finance to confirm the tax treatment of these types of benefits, and if necessary, develop the appropriate legislation to support the following tax treatment of these benefits. In CALU´s view:

1. These life and disability benefits should not result in a disposition of an interest in the life insurance policy provided they are paid as a consequence of the death of a life insured under the policy, or the disability of a life insured under the policy. See also point 4 below.
2. There should be an appropriate adjustment to the ACB of the insurance policy, as has been previously suggested by Finance. Note: assuming such benefits are "tax  free," CALU believes there should be a corresponding reduction in the ACB of the policy to reflect this payment to a beneficiary. The current rules in the Income Tax Act do not contemplate such a reduction, and could create unintended tax benefits for policyholders.
3. It should not be a requirement that the amount paid in respect of a life or disability benefit be pre-determined in the contract except to the extent of the maximum amount payable, so that policyholders are not forced to utilize this benefit if their economic circumstances do not require it.
4. CI benefits should be included in the type of payments that qualify as "disability benefits" for purpose of this discussion.

We will keep members advised as discussions on this matter progress with the Department of Finance.

Copyright the Conference for Advanced Life Underwriting, March 2010

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