| ||||||||||||
A lot of U.S. citizens live overseas — about 5.5 million by one estimate.1 And a good portion of those citizens abroad own life insurance that was purchased in the United States. But how many of those people are aware that the insurance that they own, particularly permanent life insurance, may not be treated the same, tax-wise, as it would be if they still lived in the United States?
Life insurance typically gets different tax treatment than other types of financial vehicles. But each country has its own definition of life insurance, and, as a result, each country’s insurers create policies specifically designed to qualify as life insurance under the laws of that country.
Therefore, it is always a good idea when moving to another country to see what will happen to any life insurance policy you may own and whether the financial benefits of that policy will remain in place.
This will require some discussion with tax and legal advisors in the country you are leaving as well as the one to which you are moving to determine the best course of action for an existing policy.
What life insurance is … in the United States
Life insurance in the United States is governed by a set of specific rules and definitions that are laid out by Internal Revenue Code (IRC) Section 7702. These rules are intended to put financial limits on what qualifies as permanent life insurance.
Insurance policies issued by U.S. insurers are designed to meet the financial limits set out in those rules to be considered life insurance. If the policy purchased meets the U.S. definition, and the policyowner lives in the U.S., the death benefit is typically tax free to a beneficiary. And there are other potential tax benefits for the policyowner as well, like tax-deferred growth in the cash value of the policy. (Related: The tax benefits of life insurance)
This may not happen if the policyowner does not live in the United States because the policy will be judged by the laws of the country where they live and may not have the same living benefits as it would under the U.S. tax code if it is owned individually.
What life insurance is … in Canada
For example Canada, our neighbor to the north, has a different definition of life insurance from the United States. This can create challenges for taking U.S. life insurance, particularly permanent life insurance that builds cash value over time, across that border.
Under Canada’s Income Tax Act, life insurance has been defined into two categories, either as exempt or non-exempt.
- If a life insurance policy is deemed to be exempt under Canada’s definition, it should have similar tax treatment as U.S. life insurance policies do.
- Non-exempt Canadian life insurance policies are taxed yearly on the income generated by the policy's cash value.
While treatment may be similar, the U.S. and Canada have different actuarial tests. A life insurance policy that was designed to qualify under one may not qualify under the other.
This presents a challenge when a U.S. life insurance policyowner moves to Canada. The policy that qualified as a U.S. permanent life insurance policy now needs to also qualify as life insurance based on the Canadian rules to continue enjoying tax-deferred growth. If it is found to be non-exempt, the policyowner will be subject to taxation on the annual growth of the cash value.
There are many types of U.S. life insurance products as well as different policy nuances based on the U.S. insurance company from which the policy was purchased. As a result of these differences, there is no guarantee that a U.S. life insurance policy would qualify for tax benefits in Canada. Even if it did initially qualify, there’s likely no guarantee it would continue to do so year after year.
England, Japan, and beyond
The United Kingdom (U.K.) also has tax rules that apply to owning foreign insurance policies and living there. A permanent life insurance policy may be taxed on the inside buildup of cash value depending on the following:
- The type of life insurance policy it is.
- What type of payment may be received.
- Additional rules as set out by HM Revenue and Customs, the taxing authority in the U.K.
In Japan, the death benefit on a life insurance policy is potentially subject to income tax, gift tax, or inheritance tax based on the insured, payer, and beneficiary’s relationship. This could have ramifications for both permanent and term life insurance policies.
These are simply three examples of countries that have rules different from that of the United States. Given there are close to 200 countries in the world, that makes for a lot of different definitions of life insurance. And so, there is a lot of potential for an individual to receive different taxation than expected on a purchased life insurance policy.
The same is true for a foreign life insurance policy being brought to the United States. It will be judged based on U.S. law, and, if it doesn’t match the U.S. definition, it will not be considered life insurance.
A life insurance policy might not be high on the list of items to be concerned about when making a move — especially an international one. But these small nuances to owning insurance can catch people by surprise. So being aware of the potential for different taxation is key. And that’s what makes it important to get tax and legal advice prior to a move in order to determine how the life insurance you own — or the life insurance you may be planning to purchase — will be treated.
Discover more from MassMutual …
What are living benefits in a life insurance policy?
Married to a non-citizen? 3 estate planning traps
Retiring abroad? Your plan and checklist
____________________________