Life Insurance Policy Loans in Canada: Borrowing Against Cash Value
A life insurance policy loan is money your insurer advances against the cash value of a permanent policy, such as whole life or universal life, while the coverage stays in force. The insurer charges interest, and anything still owed when you die comes off the death benefit. In Canada the loan can also be taxable: the Income Tax Act treats a policy loan as a disposition, so any part of it above the policy's adjusted cost basis (ACB) is income in the year you borrow.
| Option | What it does | Tax |
|---|---|---|
| Policy loan | Borrows against the value; coverage stays | Amount above the ACB is taxable |
| Partial withdrawal | Takes value out for good; can't be repaid | Amount above a prorated ACB is taxable |
| Full surrender | Ends coverage; pays cash value minus loans | Amount above the ACB is taxable |
Permanent policies usually build up a cash value, the amount you would get back if you cancelled; term policies have none, so there is nothing to borrow against. This guide covers keeping the policy while you borrow or withdraw. Cashing out completely is covered in Cash Surrender Value: What Happens When You Cash Out a Life Insurance Policy in Canada, and the two policy types in Term vs Whole Life Insurance: A Plain-English Comparison.
How a life insurance policy loan works
The Income Tax Act defines a policy loan as an amount an insurer advances to a policyholder under the policy's own terms. The policy is the security: one insurer's sample contract says its right to recover the loan comes ahead of any beneficiary. Another insurer's consumer page notes that no credit check is involved.
How much you can borrow
The contract sets the limit; there is no standard figure. One participating whole life client guide allows loans of up to 90% of the cash value. Another insurer's sample wording sets the maximum at the policy's cash values and dividends on deposit, less a year's loan interest, unpaid premiums and existing loans.
Interest and repayment
The insurer sets the rate and can change it. In one sample wording, interest is charged daily, compounded annually and added to the loan each policy year, and the rate resets every anniversary. Neither sample contract sets a repayment schedule; you may repay at any time. Unpaid interest simply becomes more loan.
What a loan does at death
If a loan is outstanding when the insured dies, the insurer deducts it, with interest, from the death benefit and pays the beneficiary the rest. For an exempt policy, a payment because of the insured's death is not a disposition under section 148, so the loan shrinks the payout without creating a tax bill. Taxes at death are covered in Death Duties in Canada: What the CRA Actually Takes When You Die.
Get a Free Quote →Partial withdrawals: value out for good
A partial withdrawal, or partial surrender, takes part of the cash value out for good. One insurer notes that it permanently reduces the cash value and the death benefit and, unlike a loan, can't be paid back in. On universal life, the account value also pays the monthly charges; one client guide warns that if none is left to pay a charge, the policy could lapse. The three ways to reach your cash value are set side by side in Cash Surrender Value of Life Insurance: A Canadian Guide.
The automatic premium loan
An automatic premium loan pays a missed premium out of the cash value, as a loan. One sample wording does this for any premium still unpaid 31 days after its due date, if the net cash value covers it; another applies it at the end of a 31-day grace period. Both charge interest on it like any policy loan.
That is the benefit and the catch: the policy stays in force instead of lapsing, but the balance builds quietly, with interest compounding on top. If the loan plus interest passes the cash value, the policy ends, in one wording 31 days later unless you pay. For tax, the Act leaves a loan used right away to pay a premium out of the loan's proceeds, so an automatic premium loan creates no gain when it is made, but the premium it pays isn't added to your ACB.
When a policy loan is taxable
Inside an exempt policy, growth isn't taxed year by year; taking money out is different. Section 148 of the Income Tax Act lists a policy loan as a disposition, like a surrender, and subsection 148(1) adds to your income the amount by which a disposition's proceeds exceed the ACB. For a loan, the proceeds are the amount borrowed, less any part used right away to pay a premium, capped at the cash surrender value less existing loans.
The ACB starts with the premiums you have paid and is reduced over time by the net cost of pure insurance. The gain is income in full, not a capital gain, and the insurer reports it on a T5 slip, in box 14.
Say, for example, a policy has a cash surrender value of $60,000, no loans and an ACB of $20,000 (round numbers for illustration, not a real policy). Borrowing $30,000 creates a $10,000 policy gain, taxed in the year of the loan. The loan also uses up the ACB: the Act subtracts the $30,000 and adds back the $10,000 already taxed, leaving zero. If the owner later repays the loan, paragraph 60(s) allows a deduction for repayments, up to the $10,000 of loan gains reported, less repayments already deducted.
Partial withdrawals are taxed differently
Subsection 148(4) gives the part you withdraw only a proportional share of the ACB: for a policy issued after 2016, the ACB times the withdrawal, divided by the cash surrender value less loans (earlier policies generally use a figure called the accumulating fund). In the same example, treated as issued after 2016, a $15,000 withdrawal carries $5,000 of ACB, so $10,000 is taxable. A $15,000 loan would be measured against the whole $20,000 ACB: no tax now, but the ACB falls to $5,000.
If the loan outgrows the cash value
An overloaned policy is one where the loan and its compounding interest catch up with the cash value. Both sample contracts end the policy at that point; one allows 31 days to make a payment first. When the policy ends, so does the coverage.
Because each loan is a disposition, any tax on borrowing beyond the ACB was charged in the years you borrowed. When the policy ends, the loan and interest are deducted from the cash value, and the Act's proceeds are what you are entitled to receive: for a surrender, the cash surrender value minus the loan and interest it pays off. Section 257 also stops the ACB going below nil. So the taxable gain at the end can't exceed the cash left over, and if the loan has swallowed the whole value, nothing is taxed then. The trap comes earlier: a big loan can bring a T5 slip and a tax bill for the year you borrowed, on money you still owe.
More on this topic: Cash Surrender Value: What Happens When You Cash Out a Life Insurance Policy in Canada · Life Insurance Glossary: 30 Terms Explained Simply
Deducting policy loan interest
Only in limited cases. Interest you pay on a policy loan normally counts as a premium under section 148, which adds it to your ACB. If you borrowed to earn business or investment income, paragraph 20(1)(c) may allow a deduction instead, limited by subsection 20(2.1) to interest the insurer verifies as paid in the year and not added to the ACB. The CRA says to have the insurer complete Form T2210, Verification of Policy Loan Interest by the Insurer; for business income, it says to have the interest verified before June 15 of the following year.
Before you borrow: what to ask your insurer
Get these answers in writing:
- The most you can borrow today, and the interest rate and how it is set.
- Your ACB, and how much of the loan you are considering would be a taxable gain.
- For a withdrawal instead, the taxable part and the effect on the death benefit.
- An in-force illustration showing the loan's effect on the death benefit and on lapse.
- Whether the automatic premium loan is on, and any balance it has built up.
- What notice you will get if the loan nears the cash value.
If the coverage is there for your family, keep the loan well below the cash value so the policy is still in force when they need it.
These are general rules for individually owned policies. Contract terms vary, and the tax depends on your own policy's figures, so get them from your insurer and confirm the tax with an accountant before you borrow or withdraw.
Sources
- Government of Canada, Justice Laws Website: Income Tax Act, sections 148, 138, 60, 56, 20 and 257
- Canada Revenue Agency: T5 Guide: Return of Investment Income; Line 22100: Carrying charges, interest expenses, and other expenses; Line 8710: Interest and bank charges; T2210 Verification of Policy Loan Interest by the Insurer
- Financial Consumer Agency of Canada: Life insurance
- Sun Life Assurance Company of Canada: Sun Par Accumulator II sample policy wording
- The Empire Life Insurance Company: Sample insurance contract
- RBC Insurance: Can You Cash Out a Life Insurance Policy?; RBC Growth Insurance Client Guide
- The Equitable Life Insurance Company of Canada: Your guide to Equitable Generations
Frequently Asked Questions
How long does it take to get money from a policy loan?
It depends on the contract. One insurer's sample contract asks for the request in writing and gives the insurer up to 90 days to pay, and both sample documents we read set a minimum loan amount. Ask your insurer for its usual turnaround before you count on the money by a set date.
Does borrowing against my policy stop the cash value from growing?
Not necessarily. One participating whole life client guide says borrowing against the policy doesn't pause its cash value growth, but loan interest keeps compounding, so the value left after the loan can still shrink. A loan can also block other features: that guide allows premium offset, using the policy's cash value to pay the premiums, only when no policy loans are outstanding.
Can policy dividends pay off a policy loan?
If your participating policy's terms apply dividends to a loan, they can reduce it automatically. For tax, paragraph 148(2)(a) of the Income Tax Act leaves out of a dividend's proceeds the part applied to repay a policy loan as the policy provides, so that part creates no taxable gain. Ask your insurer which dividend options your policy offers.
Can I reinstate a policy that lapsed while it had a loan?
Possibly. Both sample contracts we read allow a policy that lapsed for unpaid premiums to be reinstated within two years if you pay the overdue premiums and the outstanding loan with interest; one also asks for new evidence of insurability. Timing matters for tax: under section 148, a lapse for unpaid premiums is not a disposition if the policy is reinstated no later than 60 days after the end of the calendar year in which it lapsed.
What happens to a policy loan if I switch to reduced paid-up insurance?
In one insurer's sample contract, the coverage drops to the policy's paid-up value less the outstanding loan and interest, no further premiums are due, and the cash value is no longer available. Another insurer's wording won't allow the change if it would make the policy non-exempt for tax. Ask for the paid-up amount with and without repaying the loan first.
