Using Life Insurance as a Capital Gains Relief

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By Matthew Roberts

Updated on January 23, 2025

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By Matthew Roberts

Updated January 23, 2025

Visit author page

4 minute read

When Canadians think of taxes, many focus on income tax or sales tax. However, capital gains tax can also carry a significant financial burden. This tax is applied to profits from selling or transferring assets like real estate, stocks, or businesses. This tax burden becomes especially pressing at death, when the government treats most assets as if they were sold at fair market value, potentially leaving heirs with a sizeable bill known as a “deemed disposition” tax.

In response to this growing pressure, more Canadians are looking for strategies to soften the blow of capital gains taxes. One approach that has gained considerable traction is using life insurance as a kind of safety net, providing tax-free proceeds that can be used to cover or offset capital gains tax. How can one use life insurance as a wealth transfer tool? How does a life insurance policy help with capital gains tax while you’re still alive? Read on to find out what you need to know about using life insurance as a relief for capital gains tax.

How Life Insurance Can Help Offset Capital Gains Tax

While life insurance is generally perceived as a safety net for loved ones in case of untimely death, it can also be used as a valuable estate planning tool. Permanent life insurance policies (such as whole life or universal life) offer a death benefit that is usually paid out tax-free to beneficiaries. This payout can be used to cover funeral costs, estate taxes, and other expenses, including capital gains tax. Here are a few ways that life insurance can help offset the tax from capital gains:

Directly Covering the Capital Gains Tax

Suppose you have an asset with a large unrealized gain, such as a lakefront cottage purchased decades ago for a fraction of today’s value. By the time of your passing, the cottage may have appreciated substantially, triggering a large tax bill on that gain.

A life insurance policy can be structured so that the death benefit roughly matches the anticipated tax owed. Instead of selling the cottage or using liquid reserves, your beneficiaries can use the policy’s proceeds to settle the tax liability, allowing them to retain ownership of the property if they choose.

Potential for Tax-Advantaged Growth During Lifetime

When discussing life insurance, most people will usually only consider the death benefit. However, permanent life insurance policies can also provide a way for the cash value to appreciate over time in a tax-sheltered environment. Many whole or universal life policies offer an investment component, allowing the policyholder to leverage their life insurance premiums for long-term growth. These variable life insurance policies typically allow the policyholder to withdraw part or all of their gains from the investment at some point during their lifetime.

Using Multiple Policies for Greater Flexibility

Sometimes, individuals and families find that a single life insurance policy isn’t enough to cover multiple assets, beneficiaries, or estate-planning scenarios. In these cases, taking out multiple life insurance policies can make sense. For example, you might carry a whole life policy to provide a base level of coverage for your family cottage and a separate universal life policy tied to a business succession plan.

This approach allows each policy’s death benefit to be specifically allocated to cover the capital gains tax on a particular asset without overextending coverage or mixing funds. Multiple policies also offer flexibility if the value of one asset changes significantly over time or if you decide to sell one of your properties or businesses.

Examples and Case Studies

Alice, aged 70, owns three rental properties in Ontario. She purchased them decades ago when real estate prices were far more modest. Now, each building has a sizable unrealized gain. Fearing that her children might be forced to sell one or more properties to cover the capital gains taxes upon her death, she purchases a permanent life insurance policy.

The death benefit is structured to match the projected tax liability on the estimated fair market value of the properties. When Alice passes away, her children file her final tax return and realize a large capital gains tax, but the insurance proceeds provide enough liquidity to cover this cost. As a result, they can keep the properties and continue collecting rental income—a legacy Alice intended to leave behind.

Sam founded a small manufacturing company 30 years ago. Now nearing retirement, he wants to ensure his two children can continue operating without facing a crushing tax burden. Upon Sam’s passing, the shares in his company may trigger a significant capital gains event. To plan for this, Sam decides to purchase not just one but two life insurance policies to cover different facets of his estate plan:

Personal Policy for Family: Sam holds a permanent life insurance policy in his own name, with his family members as the beneficiaries. This policy is designed to provide a tax-free death benefit that his loved ones can use for personal expenses or other family needs.
Corporate-Owned Policy: The second policy is owned by the company itself, with the corporation named as the beneficiary. The death benefit from this policy is intended to help the business cover any capital gains tax resulting from the deemed disposition of Sam’s shares and to finance any buy-sell agreements if needed. Should Sam pass away, the company would receive tax-free proceeds and be in a position to either redeem shares from the estate or manage other transition-related costs without scrambling for liquid assets.

Key Advice from MyChoice

If you have a real estate asset, stock portfolio, or business that may be subject to capital gains tax upon your death, make sure to take out a life insurance policy with a sufficient death benefit to cover the tax.
Regularly review and update your life insurance policy as changes in your life occur. For example, you may want to raise the death benefit to account for a newly acquired property or business venture.
If you have a complex estate with many assets, taking out multiple life insurance policies may be a good idea to easily offset the capital gains tax on each asset.

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