Is My Policy Loan Over My ACB?

A statement arrives. On one line your policy loan reads, say, 70,000. On the line below, the adjusted cost basis reads 50,000. The loan is bigger than the basis, and the rule you once heard was that a loan above the basis is taxable. It is a reasonable moment to worry. In most cases it is also the wrong conclusion, and the reason sits on the statement itself.

This page walks through that one situation: what the two numbers mean, why setting one against the other counts your loans twice, when a policy loan really does create a taxable amount, and what to do about the interest from here. It is general information written by a licensed insurance professional. The figures that decide your own case come from your insurer, and the tax answer for your return comes from your accountant.

Does a loan balance higher than my ACB mean I owe tax?

Not by itself. The adjusted cost basis (ACB) your insurer reports is calculated after your loans have been taken off it. Comparing that figure with your loan balance subtracts the same loans a second time. A policy loan is taxable only to the extent it was larger than the ACB immediately before it was taken.

The confusion is understandable, because the rule people remember is true. Under the Income Tax Act, a policy loan is a disposition of part of your interest in the policy, and subsection 148(1) includes in income the amount by which the proceeds of a disposition exceed the adjusted cost basis immediately before it. In plain terms: when you borrow, the loan is measured against the ACB as it stood that day. Whatever part of the loan is covered by the ACB is not taxed. Whatever part goes beyond it is income for that year.

What people forget is the second half of the same mechanism. The moment the loan is measured, the ACB is reduced by it. So the ACB on your next statement is no longer the figure the loan was measured against. It is what was left after the loan was subtracted. That is why the two numbers on the statement cannot be compared directly, and why the question to ask is simpler than it looks: is the ACB shown after your loans still above zero?

If it is, your loans to date have not used it up. There is no gain to report from them. If it has reached zero, the next dollar you borrow is measured against nothing, and that is the point where tax begins.

What does the ACB on my statement actually include?

The adjusted cost basis is a running calculation, and your insurer keeps it up to date for you. It goes up when you pay premiums. It goes down when you take money out, including by a policy loan, and for most contracts it also goes down a little every year by the cost of the insurance itself.

Subsection 148(9) of the Income Tax Act defines it as a list of additions and subtractions. On the addition side are the premiums paid on the contract, amounts from earlier dispositions that were already included in your income, and repayments of policy loans within a ceiling. On the subtraction side are the proceeds of every earlier disposition, which is where each policy loan comes off, and, for a policy acquired after 1 December 1982, the net cost of pure insurance for each year, an amount the insurer determines under the regulations.

Two things follow from that list.

First, the ACB is not a number you can rebuild from your own records. It needs every premium, every loan, every repayment and a yearly insurance cost that only the insurer calculates. When you want the figure, ask the insurer for it, in writing, as of a stated date.

Second, when the insurer reports an ACB after a loan, the loan is already in it. Insurers state the rule the same way in their own planning material: Equitable Life's guide for tax and estate planners says the proceeds of a policy loan "are tax free until the ACB is reduced to zero" and that the amount of a policy loan in excess of the ACB is taxable. The ACB is the measure that shrinks as you borrow. It is not a second, separate limit that the loan balance has to stay under.

Why does comparing the loan with the ACB count the loans twice?

Because both numbers already contain the loans. The loan balance is the total you have borrowed, plus any interest added to it. The ACB shown after the loans is the basis that was left once those same loans were subtracted. Subtracting the loan balance from it again removes each dollar you borrowed twice.

A short example makes it plain.

Illustrative example. Suppose the ACB of your contract was 120,000 before you borrowed anything, and you then took policy loans totalling 70,000. Each loan was measured against the ACB that stood on its date, and none of them was larger than what was left, so none of them created a taxable amount. After the loans, the insurer reports an ACB of 50,000, which is 120,000 less the 70,000 you borrowed. For simplicity this ignores the yearly insurance cost, which would bring the 50,000 down a little.

Your statement now shows a loan balance of 70,000 and an ACB of 50,000. The loan is higher than the ACB. Nothing is taxable. The 70,000 was already measured against 120,000, and 50,000 is simply what remains. If you subtract the 70,000 from the 50,000 and conclude you are 20,000 over, you have taken the 70,000 off twice.

The same example shows where the real line is. From here, a further loan of up to 50,000 would still be covered by the remaining ACB. A further loan of 60,000 would go 10,000 beyond it, and that 10,000 would be income in the year of the loan. The line moves every time you borrow, repay or pay a premium, and it moves down a little every year with the insurance cost. That is why the current figure matters more than any figure you remember.

When does a policy loan actually create a taxable amount?

When the loan is larger than the ACB immediately before it is taken. The excess is included in your income for that year as ordinary income, not as a capital gain. The insurer determines the amount and reports it, and after such a loan the ACB stands at zero, so the next loan is taxable from its first dollar.

Three situations make that more likely than people expect.

A contract that has stopped receiving premiums. Premiums are what add to the ACB. When they stop, the yearly insurance cost keeps coming off while nothing goes on, and the ACB drifts toward zero. An older, paid-up contract with a large cash value can have a small ACB, and a loan against it can be taxable almost from the start.

A series of loans over several years. Each loan takes its own bite out of the ACB. A contract that comfortably covered the first loan may not cover the fourth.

Interest that is added to the loan instead of being paid. That is the subject of the next section, and it is the one most people can control.

If you are ever unsure whether a loan crossed the line, do not guess from the statement. Ask the insurer whether any policy gain has been reported on the contract, and in which year. The page on when a policy loan becomes taxable sets out the rule in full, including how repaying a taxed loan gives a deduction later.

What happens to the interest I do not pay?

Under most contracts it is added to the loan, often on the policy anniversary, and from then on it earns interest of its own. The Canada Revenue Agency has also said that capitalizing policy loan interest this way is itself a disposition. Paying the interest before it is added keeps the balance from growing and keeps the tax picture simple.

Look at your loan balance and you may find part of it was never money you received. It is interest that came due, was not paid, and was added to what you owe. Over several years that part can grow to a real sum, and because interest is then charged on it too, it compounds. The larger the balance grows against the cash value, the less room the contract has left.

There is a tax side as well. In a technical interpretation dated 31 May 2017 (file 2016-0658641E5), the Canada Revenue Agency said that the capitalization of policy loan interest results in a disposition. It went on to say that where the capitalized interest is being deducted, the amount capitalized must be included in income, and that where it is not deductible, there is no income inclusion and no effect on the ACB. You do not need to follow every step of that reasoning. The practical point is enough: interest that is paid does not raise any of these questions.

So here is the discipline, and it is a simple one. Find the date your insurer adds unpaid interest to the loan, which is usually the policy anniversary and is stated in your contract or on your statement. Pay the year's interest before that date. Put it in your calendar the way you would a property tax instalment. Small, regular and on time is the whole requirement.

Can I deduct the interest I pay?

Sometimes, yes. Interest on a policy loan can be deductible when the loan proceeds were used to earn income from a business or from property, and only if the insurer did not add the interest to the policy's ACB. The insurer confirms the interest on Form T2210. Your accountant makes the claim.

If you borrowed against your policy to buy equipment for your business, to fund inventory, or to acquire a rental property, the interest you pay may qualify. If you borrowed for a family trip or a personal debt, it does not. The use of the money decides it, not the label on the loan.

The Canada Revenue Agency's guidance on Line 8710, Interest and bank charges asks you to have the insurer verify the interest on Form T2210 before June 15 of the following year. The steps, from asking for the form to handing it to your accountant, are set out one by one on the policy loans page. One more reason to pay the interest rather than let it be added: only interest you actually pay can be claimed.

A deduction lowers the after-tax cost of the interest. It does not make the loan free. The interest is still paid to the insurer, and it is still a real cost of using the money.

Should I replace the policy loan with a bank loan?

It can be a sound choice, and it deserves a careful decision rather than a quick one. While your ACB is above zero, there is no tax deadline pushing you. Compare the rate, the repayment terms and the security each lender asks for, and choose the terms that suit your cash flow.

Here is what changes if you use a bank loan to pay down the policy loan.

The ACB comes back. Repaying a policy loan adds the repaid amount back to the ACB, within the ceiling in the definition, as long as that part of the loan was never taxed. If part of an earlier loan was taxed, paragraph 60(s) of the Income Tax Act gives a deduction for the repayment of that part instead. For most people borrowing within their ACB, the effect is simply that the basis is rebuilt as the policy loan is repaid.

The bank loan is a different kind of debt. A loan from a bank or another lender, secured by an assignment of the policy, is not itself a disposition of the policy under subsection 148(9). Borrowing that way does not reduce the ACB.

The interest rules are the same kind of rules. Interest on money borrowed for business purposes is generally claimed on the same Line 8710, whoever the lender is, and your accountant will want to see that the new loan is traced to the same business use.

What does not change is that both are debts. The bank will have its own conditions, reviews and repayment schedule. The policy loan had none of those, and some people value that flexibility more than a lower rate. There is no single right answer here. There is only the answer that fits your business and your cash flow, and you are allowed to take the time to find it.

What should I ask my insurer?

Ask in writing, and ask for figures as of the same date, so they can be read together.

1. The adjusted cost basis of the contract today, after all loans.
2. The loan balance on the same date, and how much of it is interest that was added rather than paid.
3. The date each year when unpaid interest is added to the loan, and the current loan interest rate.
4. Whether any policy gain has ever been reported on the contract, and for which year.
5. Form T2210 for any year in which you paid interest on money used to earn business or property income.
6. The cash surrender value, so you can see how much room the loan still leaves.

Bring the answers to your accountant, and to your annual review with the person who looks after the policy. With those six figures on one page, most of the worry in a statement like the one at the top of this page goes away.

What this page will not tell you

This page explains the mechanism. It cannot tell you your own ACB, whether a particular loan was ever taxed, or how your return should treat the interest. Those depend on figures only your insurer holds and on facts only your accountant can weigh.

The rules also have details this page leaves out on purpose: loans used to pay a premium, contracts held by a corporation, and the ceiling on how much a repayment can add back to the ACB. Each can change the answer. The contractual terms of any policy are those of the issuing insurer, policy dividends are not guaranteed, and nothing here is tax or legal advice.

Who this does not suit

This page is for someone who already has a policy loan and wants to read a statement correctly. It is not a reason to take a loan, and it does not make a policy loan the right tool for every need.

If your contract is old and paid up, with an ACB near zero, a new loan is likely to be taxable, and the numbers deserve a conversation before you borrow. If you would struggle to pay the interest each year, a policy loan that keeps growing puts the contract itself at risk, and another source of money may serve you better. And if your statement shows an ACB of zero, the reassurance on this page does not apply to you: talk to your accountant first.

If you would like to go through your own statement together, bring it to your annual review, or book a conversation whenever it suits you. There is no rush. Understanding the two numbers is the first step, and you have taken it.