Are returned life insurance premiums taxable? What you need to know

When a life insurance policy reaches its end, some policyholders may receive a pleasant surprise: a return of the premiums they paid over the years. But before celebrating, it’s important to understand how the Canada Revenue Agency (CRA) views this type of payout. A recent CRA technical interpretation (2024-1041441E5, dated March 19, 2025) sheds light on how these payments are taxed. 

This article considers the CRA’s position on what a return of premium actually means and what implications that has on the taxation of a life insurance policy at maturity. 

What Is a return of premium benefit? 

A return of premium benefit is a feature offered in some term life insurance policies. If the insured person survives the full term of the policy (20 years in the case at hand) the insurer may refund all or part of the premiums paid. It’s a way to reward policyholders for staying healthy and maintaining coverage. 

While not very common, these policies can be attractive because they offer a kind of “money-back guarantee.” To the layperson, hearing “return of premium” would likely sound as though the money they paid, or some portion of it, will be return to them. And since those premiums were paid with after-tax dollars, it would be a reasonable expectation that the return of said premiums would be tax free. However, the tax treatment of these returned premiums is more complex than it might seem. 

The definition of “disposition” under section 148(9) of the Income Tax Act includes surrendering or otherwise giving up your interest in a life insurance policy – and this includes when the policy reaches maturity. When a disposition occurs it is considered a taxable event that would result in a policy gain. Specifically, subsection 148(1) and paragraph 56(1)(j) of the Income Tax Act require the policyholder to report any policy gain as income.

A policy gain is the difference between the proceeds of disposition (POD) and the adjusted cost basis (ACB). If the POD is greater than the ACB, the difference is taxable. 

The CRA holds the position that the definition of POD is broad enough to include any amount received by a policy owner at the disposition, and this would include the return of premiums.

The ACB calculation is more complex, but generally, the ACB is calculated as the total premiums paid plus any previously reported income, less the net cost of pure insurance (NCPI).

The NCPI is a measure of how much the actual insurance coverage costs over time. It’s calculated using standard mortality assumptions, and therefore the NCPI increases as the insured person ages. This increase in NCPI gradually grinds down the ACB of the policy. And when the ACB is reduced that makes it more likely that there will be a policy gain when the policy matures and the POD are paid to the policy owner. 

Why is the return of premium taxable? 

This is where many policyholders are surprised. After all, they paid the premiums using after-tax dollars, and they didn’t claim any tax deductions for those payments. So why should the return be taxable? 

The CRA’s position is based on the idea that what’s being returned isn’t just your original premiums. Instead, it’s a portion of the investment income earned by the insurer using your premiums. In other words, the insurer didn’t just hold your money; they invested it and earned income. When they return that money to you, part of it reflects those earnings. 

This view is supported by a Tax Court of Canada case: White v. The Queen (2008 TCC 414). In that case, Justice Mogan explained that the returned premiums were not simply a refund of what the policyholder paid. Instead, they represented part of the insurer’s earnings, which are taxable under subsection 148(1). 

Justice Mogan wrote: “What the insurer paid as a benefit upon the expiry of the term was not, in a business sense or in an income tax sense, any part of the premiums for life insurance. It was something else. It was part of the insurer’s earnings. Under subsection 148(1), it was income.” 

This reasoning supports the CRA’s view that the policyholder should be taxed on their share of the insurer’s earnings. 

Conclusion: Not all returned premiums are tax-free 

The CRA’s recent interpretation clears up a common misconception: just because you’re getting your premiums back doesn’t mean it’s tax-free. In many cases, a portion of that return reflects investment income earned by the insurer – and that portion is taxable. If you receive a return of premium when your policy matures, and there is a taxable policy gain, the insurer is required to issue a T5 slip. The gain will appear in Box 14 of the T5 slip, labeled “Other income from Canadian sources.” If you receive a T5 slip, it’s a clear sign that the CRA considers part of your return of premium to be taxable. 

Understanding these rules can help you avoid surprises at tax time and make informed decisions about your life insurance coverage. Whether you’re a policy owner or a financial advisor, it’s important to be aware of how return of premium benefits are treated under Canadian tax law.