Should You Buy Life Insurance to Cover the Tax on RRSPs When You Die?

If you have a large RRSP or RRIF and you’re thinking ahead about estate planning, you’ve probably heard this question before:

“Should I buy life insurance to cover the tax hit on my RRSP when I die?” and "Do I (my family) pay taxes on my RRSPs when I die?" The answer is "it depends".

I’ve been asked this by clients looking for a CPA in Ottawa more times than I can count. The short answer? It depends on your goals, your heirs, and your cash flow. But let’s break it down so you know exactly what you’re dealing with.

Why Is There a Tax Problem with RRSPs When You Die?

When you die, the CRA treats your RRSP or RRIF as if you cashed it out all at once, unless you’ve named a qualified beneficiary like your spouse or a financially dependent child.

So if you have $600,000 in your RRSP when you die, your estate could be looking at over $250,000 in taxes in some provinces. That tax bill doesn’t disappear. It has to be paid before your heirs see a dollar.

Where Life Insurance Fits In

Some people use permanent life insurance (like whole life or universal life) as a way to cover that future tax liability.

The logic is:

• RRSP grows tax-deferred
• You save on your tax bill each year you contribute
• At death, there’s a tax bill
• Insurance pays out tax-free
• Your heirs get the RRSP, and the insurance covers the CRA

Sounds simple, but like most things in tax planning, it's not a one-size-fits-all strategy.

When Life Insurance Might Make Sense

Here’s when this can actually work well:

1. You Want to Preserve Wealth for Your Kids

If your main goal is to pass on as much as possible to your children, life insurance can offset the erosion from tax.

2. You Won’t Need the RRSP in Retirement

If you’ve got pensions, real estate, or other income streams and you’re not planning to spend down the RRSP, it’s likely to get taxed at death anyway. This makes it more appealing to cover the tax cost upfront through insurance premiums.

3. You’re in Good Health

The earlier and healthier you are, the cheaper life insurance is. If you wait until your late 60s or have health conditions, the cost might outweigh the benefit.

When It Might Not Be Worth It

1. You Have a Spouse as Beneficiary

If your RRSP is rolling over tax-free to your spouse, there’s no tax hit at your death. It’s deferred until the second spouse dies. So you might be buying insurance for a tax bill that won’t exist until much later.

2. You’ll Spend the RRSP Anyway

If you plan to spend most of your RRSP or RRIF in retirement, there may be no significant balance left to worry about.

3. Cash Flow is Tight

Permanent insurance isn’t cheap. If the premiums are going to stretch your budget, you may be better off just saving or investing to cover future taxes.

Other Options to Consider

• Gradual RRSP withdrawals during your lifetime can reduce the final tax hit.
• Converting to a RRIF earlier and drawing more than the minimum can help manage taxes across multiple years instead of one massive bill.
• Leaving RRSPs to a spouse avoids tax immediately and buys time for planning.
• Charitable donations in your will can offset taxes as well.

Final Thoughts

Buying life insurance to cover taxes on your RRSP is less about “saving” tax and more about who pays the bill, your estate, or your insurance company.

If your goal is to leave more behind for your family, and you’re healthy enough to get a good policy, it can be a smart strategy. But don’t let a salesperson push you into it without seeing the numbers.

This is estate planning. It’s personal. And it has to be based on real math, not just fear of the CRA.

Need help running the numbers or figuring out what fits best for your situation? Let’s talk. I’ve helped Ottawa-based families plan for RRSP taxes, with and without insurance.

References and Further Reading:

• Moneysense – Should You Buy Life Insurance to Pay Tax Owed Upon Death?
• Invested MD – Cover Future RRSP Taxes with Permanent Life Insurance
• CPA Canada – RRSP Investment Tips

If you’ve got a large RRSP and no idea how your family will handle the tax, you don’t need to guess. A good plan goes a long way.

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This is not legally binding tax advice. This is educational analysis. Say hello if you need help.

hello@taxesmadesimple.ca

WhatsApp - 613.600.4194

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