When a Policy Loan Becomes Taxable

A policy loan produces taxable income only when its proceeds are larger than the policy's adjusted cost basis (ACB) as it stood immediately before that loan, and only the excess is income, for the year of the advance. Each loan then lowers the ACB. So the ACB on your statement has already had your earlier loans taken off, and the right test compares the next advance with that figure. Comparing your total loan balance with it counts the same loans twice.

What follows is general information from a licensed insurance professional about how the federal rules work, with worked examples you can check line by line. The figures for your own contract come from your insurer, and what they mean for your return is for your accountant, ideally a Chartered Professional Accountant (CPA), to confirm. That applies to every section, so it is said once, here. Canadian Wealth Creation Centre Inc. is not authorized to give legal, tax or notarial advice and gives none here.

When does a policy loan become taxable?

At the moment an advance's proceeds exceed the ACB immediately before it. Below that line, nothing is included in income. Above it, the excess is included for the taxation year in which the loan is made. The line is a figure the insurer holds, and it moves.

The rule sits in two places in section 148 of the Income Tax Act. Subsection 148(9) lists a policy loan made after 31 March 1978 as a disposition, in paragraph (b) of its definition. A disposition, in tax terms, is an event the Act treats as giving up part of your interest in the policy in exchange for money; a surrender is the plainest example, and an advance from the insurer is another. Subsection 148(1) then includes in the policyholder's income the amount by which the proceeds of a disposition, received in the year, exceed the ACB of that interest immediately before the disposition.

Two consequences follow. The test runs one advance at a time, on its own date. And the ACB it uses already reflects every earlier loan, repayment, premium and yearly insurance charge. A policy loan is therefore not "tax free" as a class, and it is not taxable as a class either. It is measured, each time, against a figure that changes.

If your statement shows a loan larger than the ACB, is my policy loan over my ACB? works through that case with a two-loan table. The questions below follow the tax events themselves: when each one lands, what interest does, what happens when the policy ends, and what changes for a corporation or a Quebec resident.

The approach this site explains is the Canadian application of what is known as The Infinite Banking Concept®, originated by R. Nelson Nash; the mark belongs to Infinite Banking Concepts, LLC, with which this practice has no affiliation. In that approach, advances from the insurer against a participating whole life contract do the work, which is why the taxable point matters. It is a point that some marketing of the strategy leaves out.

Why does the Act treat a loan as a disposition?

Because the definition says so in terms. Subsection 148(9) defines a policy loan as an amount advanced by an insurer to a policyholder in accordance with the terms and conditions of the life insurance policy. The lender is the insurer. You owe the insurer, and the interest is paid to the insurer. The contract governs the advance, including how the insurer sets the interest rate and when it may change it.

The Act also defines what a loan's proceeds are, and the definition has a ceiling. For a policy loan, the proceeds are the lesser of two amounts:

• the amount of the loan, leaving out any part the insurer applies immediately to pay a premium under the policy's terms; and
• the amount by which the cash surrender value immediately before the loan exceeds the policy loans already outstanding.

So the proceeds can never exceed the room left in the cash surrender value. That ceiling limits the amount measured. It exempts nothing. A new advance used to pay off an old one is two events: a repayment, with its own effect on the ACB and possibly a deduction, and a new disposition measured against the ACB immediately before it. Ask the insurer to show both steps and their figures before you sign.

Nothing has to be sold for a disposition to happen. You still own the contract, it stays in force, and the cash surrender value keeps following the contract's terms: the guaranteed values it sets out, plus any policy dividends the insurer declares, which are not guaranteed. While the policy remains an exempt policy, growth inside it is generally not taxed each year as it accrues; the conditions are on tax-deferred growth. The disposition is a tax event, not a sale, and the advance itself triggers it.

What moves the adjusted cost basis before each loan?

The ACB is a running total of additions and subtractions, defined in subsection 148(9). Its value on the day of a loan is the only figure that loan is measured against, so it helps to know what pushes it each way.

The net cost of pure insurance is the tax rules' measure of what the insurance protection cost for the year. The insurer calculates it under section 308 of the Income Tax Regulations, applying a probability of death for the year to the amount at risk, roughly what the policy would pay at death less the value built up inside it. It does not simply rise with age: age pushes it up, while a growing cash value, which shrinks the amount at risk, pulls it down. The method also depends on when the policy was issued, so two contracts of the same age can behave differently.

On a contract that no longer receives premiums, the additions may stop while the yearly charge continues, so the ACB can drift down. It is not a one-way slide. A repayment, a further premium or loan interest paid in cash and not deducted can each raise it again. That is why an older paid-up contract may produce income from the first dollar of an advance, while a younger contract with years of premiums behind it may produce none, and why the answer can change from one year to the next. The elements are described in the glossary entry on the adjusted cost basis; the figure itself comes only from the insurer.

How do the tax events line up, year by year?

Illustrative example, with every assumption stated so you can check each line. You own the policy personally. The ACB immediately before the first loan is 60,000, a figure only the insurer could supply. The cash surrender value always leaves room for the full advance, so the proceeds equal each advance. You use the money for personal spending, so the interest is not deductible. The insurance charge appears once, in year 2, at 1,500. No other premium, disposition or charge happens, and the insurer applies your repayment to the second loan. Real figures would include movements left out here, and the insurer's calculation governs.

Read the table the way your statements would show it. After step 4, the statement shows a loan balance of 75,000 against an ACB of zero. Setting one against the other would suggest you are 75,000 over the line. The real inclusion was 6,500, for year 3, from Loan B alone. Loan A was measured in year 1 against 60,000 and produced nothing.

Now read it by tax year, which is how your returns will see it:

• Year 1: nothing to report from the loan. The ACB falls to 25,000.
• Year 2: nothing to report. The premium and the interest you paid raise the ACB; the insurance charge lowers it.
• Year 3: 6,500 goes into your income. It is an income inclusion, taxed with the rest of your income at your own rates, not a tax bill of 6,500.
• Year 4: on the CRA letter's reading, capitalised interest that is not deductible changes neither your income nor the ACB, but the balance you owe the insurer grows.
• Year 6: the repayment gives a deduction of up to 6,500 under paragraph 60(s), lowering year 6's taxable income at year 6's rates. It is not a refund of year 3's tax, and the two years can come out differently.

The ACB after step 6 is our reading of the definition, which adds back a repayment up to the loan's proceeds less the amount deductible under paragraph 60(s). It is a reading, not a ruling, and the insurer's figure is the one that counts. After step 6, a further advance of up to 33,500 would sit within the ACB; anything above it would be income for the year of that advance.

What exactly lands on your return in the year a loan crosses the line?

The excess of the proceeds over the ACB, and nothing else from that loan. It is ordinary income: subsection 148(1) includes it in computing income, so the whole excess counts, with no partial inclusion as for a capital gain. It belongs to the taxation year in which you became entitled to the proceeds, which in practice is the year the advance is made.

The inclusion belongs to the policyholder. If you own the policy, it is your income. If a corporation owns it, it is the corporation's, for the corporation's taxation year. The person insured and the beneficiary are not taxed on it simply because of those roles.

The insurer calculates the amount and reports it on a tax information slip for that year. Do not treat the slip as the whole answer. It shows a number, not the working, and your accountant needs the working to check it and to plan a repayment. Do not assume tax is withheld from the advance either: the cash can arrive in full while the tax is settled later, with your return or your instalments. Ask the insurer in writing, before the advance, for an estimate of any amount it will report.

A timing point is easy to miss. An advance taken in late December and one taken in early January can land in different tax years, with different results depending on your other income. If a large advance will cross the line, the year you take it is worth a conversation with your accountant beforehand. The same holds for a repayment you plan to deduct.

What happens to the interest, paid or added to the loan?

The interest is owed to the insurer and paid to the insurer. The insurer sets the loan interest rate and can change it on the terms the contract allows. What the interest does for tax depends on two questions: whether you pay it or let it be added to the loan, and whether it is deductible.

Interest you pay in cash and do not deduct counts as a premium under paragraph (a) of the definition of "premium" in subsection 148(9). That definition takes out interest deductible under paragraph 20(1)(c) or (d). So non-deductible interest you pay raises the ACB, which gives the next advance more room. Step 3 of the table shows it.

Interest you do not pay is, depending on the contract, added to the loan balance on a date the contract sets, and from then on it bears interest too. The tax side comes from a 2017 CRA technical interpretation, file 2016-0658641E5, dated 31 May 2017. In it, the CRA described interest capitalised this way as a further policy loan, and so as a disposition.

• Where the interest is not deductible, the CRA said the capitalised amount produced no income inclusion and had no effect on the ACB, because it is treated as a loan applied to pay a premium.
• Where the interest is deductible and is capitalised, the CRA treated it as a policy loan like any other: it produces income to the extent it exceeds the ACB at that moment. The CRA's example of full inclusion assumed the ACB was already zero.

A technical interpretation is the CRA's view of the facts it was given, at that date. It is not law, and the CRA says it may not reflect its current position. Paying the interest in cash before the date it would be added keeps the question away, stops the balance compounding and, when you do not deduct the interest, raises the ACB.

Interest can be deducted only when the borrowed money is used to earn income from a business or from property, under paragraph 20(1)(c). The test follows the use of the money, not the label on the loan. The same paragraph excludes money borrowed to acquire a life insurance policy. For a policy loan, the insurer must verify the interest you paid on Form T2210, Verification of Policy Loan Interest by the Insurer, confirming that it will not add that interest to the ACB, so the same dollar cannot both be deducted and raise the policy's tax cost. The deadlines and steps are on the policy loans page.

Can a loan pay the premium without creating income?

Yes, for the part the insurer applies immediately to a premium under the contract's own terms. That part is left out of the loan's proceeds, so it gives subsection 148(1) nothing to measure. The loan is still a disposition; only its proceeds shrink.

The exclusion is narrow. It covers a premium under the policy, paid immediately after the loan, as the contract provides. It does not cover an advance you take in cash and later use for a premium, and it does not cover money used for anything else. The loan also stays a loan for every other purpose: it bears interest owed to the insurer, it reduces what is paid at death, and it counts in the outstanding balance that caps the proceeds of every later advance.

The premium paid this way does not raise the ACB the way a cash premium does. Element B of the ACB definition, as read on Justice Laws on 29 September 2026, counts premiums paid other than amounts covered by the premium-loan exclusion. For a policy issued after 2016, element E.1 adds that portion to the ACB later, when the loan is repaid. For an older policy, ask the insurer and your accountant how its figures treat a premium loan and its repayment. So a contract kept in force by premium loans can show a loan balance that rises each year beside an ACB that does not.

This matters most when a premium loan provision is running without your noticing, for example after a missed payment. The contract keeps going, but the balance, and the interest on it, grow against the cash surrender value. Check whether your contract has such a provision and whether it is active. If your loan balance rises when you asked for nothing, ask the insurer why.

What happens to the tax when the policy ends?

It depends on how it ends. With a loan outstanding, four cases matter.

Illustrative example of a surrender. Assume a cash surrender value of 90,000, policy loans of 70,000 that the surrender settles, no premium due and unpaid, and an ACB of 5,000 immediately before the surrender. The proceeds are 90,000 less 70,000, which is 20,000. The income is 20,000 less 5,000, which is 15,000. The 70,000 you borrowed is not counted again, because each of those loans already came off the ACB when it was made.

The cheque you receive after settlements is not the figure that decides the income: the Act's proceeds and the ACB are. Before you surrender, ask the insurer in writing for the proceeds of the disposition, the loan settlement, the ACB immediately before, and the tax reporting it expects (a T5 slip, federally). Have your accountant review them even if little cash will be paid. Surrendering on purpose is a separate decision, covered on the cash surrender value.

Paragraph (g) is written for lapses caused by unpaid premiums. If a contract ends because the loan balance overtook the value securing it, do not assume the exception applies; ask the insurer and your accountant in writing. Whatever the route, lapse is where a loan can do the most damage, because the tax, the lost coverage and the loss of the contract all arrive together. If the balance is getting close to the cash surrender value, act while the policy is in force: pay the interest, repay part of the loan, or ask the insurer what the contract offers. Check more often than once a year when the margin is narrow.

A contract can also end its exempt status without ending. A policy that stops being an exempt policy is treated as disposed of, with its own tax consequences, explained in the exempt test and what happens when a contract fails it. The insurer tests the contract under the regulations and can tell you where it stands.

How is a loan secured by the policy from another lender different?

It is not a disposition. Paragraph (f) of the definition in subsection 148(9) leaves out an assignment of all or part of an interest in the policy made to secure a debt or a loan other than a policy loan. Taking such a loan from a bank or another lender, secured by an assignment of the policy, creates no income and leaves the ACB where it was.

The outside lender route has its own costs and conditions. The lender sets its rate and terms, can review or call the loan under its agreement, and at death is paid from the proceeds under the assignment before the beneficiary receives the rest. Interest on it is deductible only on the same use test. Read the lender's agreement before you sign, especially the clauses that let it review the loan. Using a new outside loan to repay a policy loan rebuilds the ACB for the untaxed part of the policy loan and gives a deduction for any part once included in income. The full comparison is on a policy advance and other credit.

A lending example with family money shows why the question "who owes whom" matters. If you take a policy loan and lend the money to a relative, there are two debts: you owe the insurer and pay it the interest, and your relative owes you. The insurer is owed its interest whatever your relative does, and the tax test on your advance is the same as for any other use.

What changes when a corporation owns the policy?

The same test applies: each advance is compared with the ACB immediately before it, and each advance lowers the ACB. The difference is whose income it is. When a corporation is the policyholder, the loan is made to the corporation, the corporation owes the insurer, and any amount included is the corporation's income for its taxation year. Any interest deduction depends on how the corporation uses the money.

Moving the money from the corporation to a shareholder is a separate transaction with its own rules. A salary, a dividend, a shareholder loan or the repayment of an amount the company owes you each has its own treatment, and the policy loan does not replace any of them.

At death, a qualifying private corporation that receives life insurance proceeds because of the death can add them to its capital dividend account, less the policy's ACB immediately before the death, under paragraph (d) of the definition in subsection 89(1). An outstanding loan reduces what the insurer pays, and who is policyholder, beneficiary and creditor can change the credit. Paying a capital dividend from that account needs an election under subsection 83(2), made on CRA Form T2054. The corporation's accountant should calculate the figures before anyone relies on them. The wider picture is on corporate-owned life insurance and in the glossary entry on the capital dividend account.

What changes for a Quebec resident?

The federal rules above apply to your federal return wherever you live in Canada. If you live in Quebec, you also file a Quebec return with Revenu Québec under Quebec's Taxation Act. An amount included in income from a policy loan, a repayment you deduct and any interest you claim all need to be checked on both returns.

For interest on money used to earn business or property income, Revenu Québec has its own form, TP-163.1-V, Interest Paid on a Loan Taken Out on a Life Insurance Policy, alongside the federal T2210. Ask the insurer whether it issues a Quebec slip as well as the federal one for any amount it reports. Then give your accountant the insurer's written calculation and ask for the treatment on both returns together, since the federal example above is not a calculation of your combined tax.

What should you ask the insurer and your accountant before you borrow?

Ask in writing, with every figure as of the same date, so they can be read together. Each question goes to the party who holds the answer.

Consents matter too. If the policy has an irrevocable beneficiary, or a lender already holds an assignment, the insurer may need that person's or lender's consent before advancing. Ask before you count on the money. The contractual terms of any policy are those of the issuing insurer, and the figures that decide your case are in its records.

Who should think twice before borrowing against a policy?

A policy loan suits someone who owns a contract they intend to keep, who can carry the interest, and who has asked for the ACB before borrowing. It does not suit every need.

If your contract is old and paid up, with an ACB near zero, a new advance may be income from its first dollar, and the numbers deserve a look before you borrow. If paying the interest each year would strain you, a balance that keeps growing puts the contract itself at risk, and another source of money may serve you better. And if you treat the loan as a way to draw income from the contract without consequence, the rule above is the consequence: above the ACB it is income, and below it, it is still a debt with interest that reduces what is paid at death.

If you do not own a policy yet, the tax treatment of loans is not a reason to buy one. First establish whether you need permanent coverage and whether you can keep paying the premiums through a bad year; spare cash alone establishes neither. Do I need permanent life insurance? is the place to start. Participating whole life insurance is insurance, not an investment, and a policy loan's tax treatment is a feature of the contract, not a return.

Reading here is free. The firm is paid by commission from the insurer if a policy is bought, which is stated at the foot of every page; ask any advisor how they are paid. Knowing where the line sits before borrowing is part of what the practice calls Infinite Financial Sovereignty®, which describes holding the highest practical level of control over the capital-flow function in one's own affairs. That control begins with knowing which dollar is taxed, and in which year.