How are life insurance proceeds treated in estate planning?

What the Law Says

Canadian law treats life insurance proceeds as contractual payments outside the estate when a beneficiary is properly designated. Provincial insurance acts and the federal Income Tax Act govern key aspects.

Under provincial insurance legislation (e.g., Ontario’s Insurance Act), a life insurance policy with a named beneficiary creates a direct contractual right. The proceeds do not form part of the insured’s estate and therefore avoid probate fees, estate administration tax, and claims by creditors of the estate.

The federal Income Tax Act confirms that life insurance death benefits paid to a named beneficiary are generally received tax-free — neither the estate nor the beneficiary pays income tax on the proceeds.

However, if no beneficiary is named, or the beneficiary predeceases the insured and no contingent beneficiary exists, proceeds flow into the estate and become subject to probate, taxes, and creditor claims.

Statutory Text

Where a person has, under a contract of life insurance, designated a beneficiary of an insurance money payable on the death of the person, the insurance money does not form part of the estate of the person.

— Insurance Act, R.S.O. 1990, c. I.8, s. 206(1) — Rights of beneficiary

Statutory Text

No amount is included in the income of a taxpayer for a taxation year in respect of a payment received by the taxpayer as a beneficiary under a life insurance policy.

— Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.), s. 148(1) — Tax treatment of proceeds

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