Is converting life insurance to an annuity taxable?

In most cases, yes. When you surrender a policy, any gain above the adjusted cost basis is taxable as income. The annuity payments you subsequently receive will also have a taxable component. However, a prescribed annuity can spread the taxable portion evenly, reducing the tax impact. Consult a tax advisor for your specific situation.

When does converting life insurance to an annuity make sense?

It makes sense when you no longer need the death benefit (no dependents, debts paid off), you're entering retirement and want guaranteed income, your policy has substantial cash value, and you want predictable monthly payments. It does not make sense if you still need the death benefit for family protection or estate planning.

Life Insurance to Annuity — Can You Convert? How It Works in Canada (2026)

Q: Can you convert life insurance to an annuity in Canada?

Yes. If you have a whole life or universal life policy with accumulated cash value, you can surrender it and use the proceeds to purchase an annuity. Some insurers also offer internal settlement options that convert the death benefit into annuity payments for beneficiaries. Canada does not have a direct tax-free 1035 exchange like the US, so surrendering may trigger taxable income.

What does "life insurance to annuity" mean?

Converting life insurance to an annuity means surrendering your permanent life insurance policy (whole life or universal life) and using the cash value to purchase an annuity — a financial product that pays you guaranteed income for a set period or for life.

Essentially, you trade a future death benefit (which your beneficiaries would receive) for guaranteed income now (which you receive during retirement). This only makes sense if you no longer need the death benefit.

How it works in Canada

Unlike the US, Canada does not have a direct "1035 exchange" that lets you swap a life insurance policy for an annuity tax-free. In Canada, the process typically involves two steps:

Surrender the policy: You cancel your whole life or universal life policy and receive the cash surrender value. Any gain above the adjusted cost basis (ACB) is taxable as income in that year.
Purchase an annuity: You use the after-tax proceeds to buy a life annuity or term-certain annuity from an insurance company. The annuity pays you guaranteed monthly income.

Some insurers offer settlement options that allow beneficiaries to receive the death benefit as annuity payments instead of a lump sum. This is a different scenario — it's the beneficiary converting, not the policyholder.

Types of annuities available in Canada

Life annuity: Pays guaranteed income for as long as you live. Payments stop when you die (or continue to a surviving partner with a joint-life option).
Term-certain annuity: Pays guaranteed income for a fixed period (e.g., 10, 15, or 20 years). If you die during the term, remaining payments go to your beneficiary.
Prescribed annuity: Spreads the taxable portion of each payment evenly over the annuity term, resulting in lower taxes in the early years compared to a non-prescribed annuity.

Tax implications

The tax impact happens at two stages: when you surrender the life insurance policy and when you receive annuity payments.

Policy surrender: Cash surrender value minus ACB equals taxable income. If you've paid $50,000 in premiums and the ACB is $35,000 (after deducting the net cost of pure insurance), and the cash surrender value is $80,000 — your taxable gain is $45,000.
Annuity payments: Each payment has a taxable and non-taxable component. A prescribed annuity levels the taxable portion, which is more tax-efficient for non-registered funds.

For full details on life insurance taxation, see our guide: Is Life Insurance Taxable in Canada?

When does converting make sense?

Good candidates:

Retirees who no longer need the death benefit (no dependents, debts paid off).
Policies with substantial cash value that could generate meaningful income.
People who want guaranteed income to supplement CPP, OAS, and pension.

Not recommended if:

You still need the death benefit for family protection, estate planning, or probate avoidance.
Surrendering would trigger a large taxable gain in a high-income year.
Your policy has strong dividend performance that would be lost.

Alternatives to converting

Policy loan: Borrow against the cash value without surrendering. The policy stays active. Interest rates are typically 5–8%.
Reduced paid-up insurance: Use the cash value to purchase a smaller, fully paid-up policy. No more premiums, smaller death benefit.
Partial withdrawal: Some universal life policies allow partial cash value withdrawals.

Learn more about accessing cash value: Can You Cash Out Life Insurance?

Frequently asked questions

Can you convert life insurance to an annuity in Canada?

Yes. Surrender your permanent life insurance policy and use the cash value to purchase an annuity. Note that Canada does not have a tax-free 1035 exchange — surrendering may trigger taxable income.

Is the conversion taxable?

Yes. Any gain above the adjusted cost basis is taxable when you surrender. Annuity payments also have a taxable component. A prescribed annuity spreads the tax impact evenly.

Can you convert term life insurance to an annuity?

No. Term life has no cash value. You can only convert permanent policies (whole life or universal life) that have accumulated cash value.

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Life Insurance to Annuity: Can You Convert and How Does It Work in Canada?