The Yearly Paperwork for a Policyowner: Statements, Adjusted Cost Basis, Tax Slips and the Interest Form

Most people who own life insurance keep the contract in a drawer and open the envelope from the insurer once a year, if that. For term life insurance, that is usually enough. For a specially designed, high-cash-value, participating whole life insurance policy, it is not. The contract has a cash value, it may carry a loan, it receives dividends, and every one of those can become a line on a tax return in the year something happens.

The paperwork is not complicated. It is just easy to ignore until the day it matters: the spring a slip arrives that nobody expected, the year a loan crosses a line on the policy's tax cost, or the week a family looks for papers after a death. On that day, a folder kept in order is worth more than any explanation.

This page sets out the papers a policyowner keeps and asks for each year, what each one tells you, and what to do with it. It is general information from a licensed insurance professional. It is not tax or legal advice. The tax rules themselves, including which events are taxed and why, are explained on is life insurance taxable in Canada. This page is about the file you keep so that those rules can be applied to your own policy.

Start with the document you already receive.

What is the annual statement, and what should you read on it?

It is the insurer's yearly report on your policy, usually sent around the policy anniversary. It is the single most useful paper you will receive, because it shows where the contract stands on one date. Read it the day it arrives, and file it with the others in date order.

The layout differs from one insurer to another, so the lines below may carry other names. What matters is that you can find each figure, or ask for it.

• The coverage in force. The death benefit today, including any paid-up additions bought with dividends.
• The premium. What is due, when, and how it is paid.
• The cash surrender value. What the insurer would pay if the contract ended on that date, before any loan is subtracted.
• The dividend. The amount declared for the year, if any, and the option it was applied to.
• Any policy loan. The balance, the interest rate charged, and the interest added since the last statement.
• The beneficiaries and the owner. As the insurer's records show them.

Two habits make the statement far more useful. First, put this year's statement beside last year's and compare the lines: did the cash value grow as you expected, did the loan balance move, did the dividend option change? Second, check the names. A beneficiary designation recorded wrongly, or never updated after a marriage or a separation, is easier to fix while you are alive than for your family to dispute afterwards.

The statement also reflects the guaranteed side of the contract and the side that depends on dividends. Dividends are declared each year by the insurer's board from the experience of its participating account, and they are not guaranteed. How each dividend option works inside the contract is set out on the dividend options and what each one does.

Why does the adjusted cost basis matter, and where do you get it?

Because it is the line that decides whether money taken out of the policy is taxed. The adjusted cost basis (ACB) is the policy's cost for tax purposes. Under subsection 148(1) of the Income Tax Act, when you dispose of your interest in a policy, the amount by which the proceeds exceed the basis is included in your income.

The basis moves every year, and it does not move the way most people expect. The definition in subsection 148(9) adds the premiums you paid and subtracts the proceeds of earlier dispositions. For policies acquired after 1 December 1982 it also subtracts the net cost of pure insurance, an amount set by regulation that generally grows as the person insured ages. Repayments of a policy loan are added back within a formula. The result is that a policy's basis often rises in the early years and then levels off or falls, even while premiums are still being paid.

Nobody outside the insurer can calculate it exactly, because it depends on the policy's own records. So the paper to ask for is simple: a written statement of the adjusted cost basis on a stated date, with the cash surrender value and any loan balance on the same date. Ask for a projection of the basis for the next several years as well. Some insurers show the basis on the annual statement. Many do not, and they provide it on request.

When to ask:

• before any policy loan, withdrawal or surrender;
• each year if you already carry a loan, because the room between the loan and the basis can close;
• before a change of ownership, a gift of the policy or a transfer to a corporation;
• when your accountant asks for it, which they will if a slip arrives.

The detail of what happens when a loan goes above the basis is on when a policy loan is higher than the ACB, and the term itself is defined in the glossary.

Which events produce a tax slip?

An event that the Income Tax Act treats as a disposition of an interest in the policy, where the proceeds exceed the basis. Paying premiums does not produce a slip. Holding the policy while its cash value grows does not either, as long as it remains an exempt policy. A slip follows something you did, or something the contract did on your behalf.

The events to watch:

• A surrender, full or partial. The proceeds above the basis are income.
• A policy loan. Paragraph (b) of the definition of disposition in subsection 148(9) names a policy loan. The part of a loan above the basis is income in the year it is received.
• Unpaid loan interest added to the loan. Interest that is not paid and is added to the balance increases the loan, and so can push it above the basis.
• A dividend received. Paragraph 148(2)(a) treats a policy dividend received as proceeds of a disposition, reduced by any part applied to pay a premium or to repay a policy loan. Whether a dividend produces income depends on the option you chose and on the basis at the time.
• A lapse with a loan outstanding. If the contract ends because the loan has reached the cash value, the loan settled at that moment is part of the proceeds.

When one of these produces income, the insurer reports it on a slip for the calendar year of the transaction. A trade publication described a case in which a policyholder received a T5 slip reporting a taxable policy gain related to a policy loan, after interest had been added to the loan. A Quebec resident also files a Quebec return, so ask the insurer which Quebec slip, if any, accompanies the federal one.

If a slip arrives that you did not expect, do not guess. Call the insurer, ask which transaction produced it, and ask for the adjusted cost basis on the date of that transaction. Then give the slip and the insurer's answer to your accountant before you file.

How do two statements side by side reveal a loan problem early?

By showing the gap between the loan and the basis shrinking before it disappears. One statement on its own tells you where the policy stands. Two statements, read together with the basis, tell you where it is heading.

Illustrative example. Assume a policy loan of $30,000 at an assumed rate of 6% a year, no interest paid, and an adjusted cost basis that stays at $36,000 over the period. These are round numbers chosen for the arithmetic. They are not any insurer's rate and not any contract's values, and a real basis moves each year.

Read the last column. Nothing happened in years one to three that anyone would notice, and no slip was issued. In year four, unpaid interest added to the loan carried it about $1,874 above the basis. Under the rules described earlier, that part is income in that year. In practice the result depends on how the insurer treats capitalised interest and on the real basis, which is exactly why the written basis statement matters.

The point is not the numbers. It is the habit. Someone who reads this year's statement beside last year's, with the basis in hand, sees the room closing two years before it closes. Someone who files the envelope unopened sees it on a slip.

What is the interest form, and when do you need it?

Form T2210, Verification of Policy Loan Interest by the Insurer, is the Canada Revenue Agency's form for policy loan interest. You need it only in one situation: when the interest on a policy loan may be deductible.

The rule sits in two places in the Income Tax Act. Paragraph 20(1)(c) allows a deduction for interest on money borrowed to earn income from a business or property. Subsection 20(2.1) then says that interest on a policy loan made by an insurer counts for that purpose only to the extent the insurer verifies it in prescribed form and within the prescribed time. It also says the verified amount must be interest paid in the year that was not added to the adjusted cost basis.

Three practical points follow.

• Most policy loans give no deduction at all. A loan used for a car, a home, a holiday or a child's tuition is not money borrowed to earn business or property income. No form changes that.
• Interest added to the loan is different from interest paid. The form is about interest paid. Interest that was capitalised into the loan is treated differently, and it also affects the basis.
• Ask before the deadline your accountant gives you. The insurer has to complete its part. If you leave the request until April, the form may not arrive in time.

If you use a policy loan for an investment property or a business, decide with your accountant at the start how the interest will be tracked. The use of the money, not the policy, decides whether interest is deductible.

What records does a repayment create?

A repayment of a policy loan can matter for tax in two ways, and each needs its own paper.

First, it can produce a deduction. Paragraph 60(s) of the Income Tax Act allows a deduction for repayments made in the year on a policy loan, but only up to the amount of that loan that was previously included in your income and not already deducted. In plain terms: if part of a loan was taxed because it went above the basis, repaying that part later can give you back a deduction. Repaying the part that was never taxed gives none.

Second, a repayment adds to the basis, within the formula in subsection 148(9). That can give you more room for a later loan before income arises.

So keep three things together: the slip from the year the loan was taxed, the insurer's confirmation of each repayment with its date, and a note of which loan it repaid. Ten years later, nobody will remember which part of which loan was taxed. The papers will.

What should go in the policy file?

One folder per policy, paper or digital, holding the papers that explain the contract from its first day. The table below lists them, why each matters and how long to keep it.

The Canada Revenue Agency asks taxpayers to keep receipts and documents for at least six years. For a policy, most of the file should outlive that period, because the basis on any future date is built from every year before it.

Add one more page at the front: a summary your family could read without you. The policy number, the insurer's name and claims contact, the owner, the person insured, the beneficiaries, any loan, where the original contract is kept, and who your accountant is. A death claim moves faster when the family knows what exists and whom to call. How a claim is paid is described on how a death claim is paid in Canada.

What if papers are missing?

Ask the insurer. It keeps the policy's records, and a written request can recover most of what a drawer has lost. Three requests cover nearly everything.

• A duplicate of the contract, with every rider and amendment that applies today.
• A transaction history: premiums, loans, interest charged and paid, withdrawals, dividends and the option each was applied to, year by year.
• A statement of the adjusted cost basis on today's date and on the dates of any past transaction you are unsure about.

What the insurer cannot rebuild is your own side of the file: why a loan was taken, what the money paid for, which loan a repayment was meant to reduce. Write those notes now for anything you remember, even briefly. A two-line note made today is better evidence than a memory consulted in ten years. The original illustration may also be hard to recover. If it is lost, ask for a current in-force illustration, which shows the guaranteed values from today forward under the contract as it now stands.

What does a policyowner's year look like?

The calendar year and the policy year rarely match. Tax runs from January to December; the policy runs from one anniversary to the next. Keeping both in view avoids most surprises.

The December line deserves a moment. If interest on a loan is left unpaid, it is usually added to the balance. That raises the loan and can bring it closer to, or above, the basis. Paying the interest before the year ends is one of the simplest ways to keep a loan from creating income nobody planned. The wider habit of reviewing a policy once a year is described on the yearly review of a family financing system.

What should the family summary page say?

Enough for someone who has never seen the policy to make one phone call and start a claim. A death benefit is paid under the contract, but a family that does not know a policy exists, which insurer issued it or where the papers are can lose time finding out. One page prevents that.

Write it in plain words and keep it at the front of the file:

• the insurer's name, its claims telephone number and the policy number;
• the person insured, the owner, and the beneficiaries with their shares;
• whether a loan is outstanding, and roughly how much on the last statement;
• where the original contract is kept, paper or digital;
• the name and contact of your accountant, and of the licensed professional who services the policy;
• for a corporate policy, which corporation owns it and who signs for that corporation.

Update the page whenever a statement shows a change, and tell at least one person you trust where the file is. The page itself does not need to be secret. It discloses the existence of a contract, not access to it, because the insurer pays only according to its own records and the proof it requires.

When a death occurs, the insurer tells the claimant which documents it needs. The family's job is easier if the summary page has already answered the first question every insurer asks: which policy, and whose life.

What changes when a corporation owns the policy?

The papers are the same, and there are more of them. A policy owned by a corporation sits inside the corporation's books, so its statements, basis statements and slips belong to the corporation's accountant as well as to you.

Two additional records matter. The first is who pays the premiums and who benefits, because a policy owned by one person and paid for by another can raise a taxable benefit question. The second applies at death: when a private corporation receives a death benefit, the amount by which it exceeds the policy's adjusted cost basis can be added to its capital dividend account, under the rules explained on the capital dividend account. That calculation needs the basis immediately before death, which is one more reason to keep basis statements on file every year.

Whether a policy should be owned personally or by a corporation is its own question, set out on personal or corporate ownership of the contract. This page only asks that, whichever you chose, the file is kept as if your accountant will need every page of it. Eventually, they will.

What do Quebec residents add?

A second return. Quebec residents file a federal return with the Canada Revenue Agency and a Quebec return with Revenu Québec. A policy gain is therefore a question for both returns, and your accountant will want to know whether the insurer issued a Quebec slip as well as a federal one.

Quebec also governs the contract itself through the Civil Code. The rules on beneficiary designations, including when a designation is irrevocable, are set there, and they affect what you can change later without someone else's consent. How the Civil Code shapes a life insurance contract is described on the Civil Code and the life insurance contract. For the yearly file, the practical point is simple: keep the insurer's written acknowledgement of every designation, because in Quebec the form of the designation can matter as much as its content.

What should you ask the insurer each year?

Short questions, asked in writing, so the answers stay in the file. Six cover almost every situation.

• What is the adjusted cost basis of my policy today, and what is it projected to be for the next five years?
• What are the cash surrender value and the loan balance on the same date?
• What interest rate is charged on my loan now, and how can it change under the contract?
• How much interest was added to my loan this year, and how much did I pay?
• Which dividend option applies, and was the dividend declared this year applied as I expect?
• Which beneficiaries and which owner do your records show?

If you used a policy loan for business or investment purposes, add a seventh: will you complete form T2210 for this year, and by what date? And if you are about to take money out of the policy, add an eighth: if I take this amount on this date, how much of it will be above my basis?

These are ordinary requests. An insurer answers them every day. What makes them valuable is asking before you act, not after.

What should your accountant receive each spring?

A small, predictable package, so that the policy never becomes the reason a return is late. Give them:

• Every slip the insurer issued for the year. Note the transaction each one is for.
• The insurer's written statement of the adjusted cost basis on the date of each transaction.
• Proof of any loan repayment. Add the year that loan was taxed, if it was.
• Form T2210, if the interest on a policy loan may be deductible.
• For a policy a corporation owns, the annual statement and the basis statement for its file.

Then ask your accountant one question that only they can answer. Is there anything I plan to do with the policy next year that would change my tax? The timing of a loan can matter. A loan taken in a year of lower income may cost less tax than one taken in a year of high income. Only someone who sees your whole return can tell you which year is which.

What this page will not tell you

It will not tell you how your own policy is taxed. That depends on its basis, its loan, its dividend option, its owner and the years in which things happened. It will not name any insurer's form or slip layout, because each insurer prints its own. And it will not tell you whether interest on your loan is deductible, which depends on how the borrowed money was used and is a question for your accountant.

It also will not make the paperwork disappear. A participating policy is a contract that runs for decades, and the papers that explain it run just as long.

Who this does not suit

Anyone who holds only term life insurance with no cash value and no loan needs very little of this file: the contract, the beneficiary form and the family summary page are usually enough.

And anyone considering a participating policy who knows they will never open an envelope or ask an insurer a question should think carefully before buying one. The contract does not require a great deal of attention, but it does require some, every year, for as long as it lasts. If that is more than you want to give, it is far better to know it before you sign than to discover it in the spring a slip arrives.