A side account is a separate, taxable account associated with a universal life insurance policy. It is used to hold excess premium payments that exceed the maximum allowable contribution under Canadian tax rules for tax-exempt life insurance policies. The side account is not part of the policy itself, and its value is kept distinct from the policy’s investment accounts. It’s held by the insurer alongside the policy but apart from its tax-sheltered accounts, so its growth is taxed every year; the investment accounts inside the policy grow tax-deferred.
Why side accounts exist
Universal life insurance allows for investment growth within the policy on a tax-deferred basis, but only up to a limit defined by the Income Tax Act. When premium contributions or cash value accumulation exceed these government-imposed limits, the policy risks losing its tax-exempt status.
To avoid this, any excess funds are diverted into a side account.
Key features of a side account
Separate from the policy
It is not included in the policy’s tax-sheltered investment accounts.
Taxable annually
Interest or growth within the side account is taxed every year
Pays out separately
On death, the value of the side account is paid to the policyowner or their estate, not to the named beneficiary under the policy.
Can be withdrawn
Clients may be able to withdraw funds from the side account at any time, subject to minimum withdrawal rules or fees.
When funds are directed to a side account
- The policyholder contributes more than the maximum premium allowed to maintain tax-exempt status.
- The investment accounts inside the policy accumulate more value than the limits allow.
- The insurer automatically transfers the excess to the side account to preserve the policy’s exempt status.
- These transfers typically occur at the policy anniversary, when the insurer performs the annual exempt test calculation.
Tax implications of side accounts
Unlike the tax-deferred investment growth inside the universal life policy, any growth in the side account is taxable in the year it is earned. This can reduce the overall tax efficiency of the strategy if the side account accumulates significant value.
Access and withdrawals
Policyowners may:
- Withdraw all or part of the side account value
- Transfer funds back into the policy (as new premium payments), if room becomes available
- Be subject to market value adjustments or administration fees, depending on the insurer
Side account vs. policy investment accounts
| Feature | Policy investment accounts | Side account |
|---|---|---|
| Tax treatment | Tax-deferred (within limits) | Taxable annually |
| Part of policy | Yes | No |
| Contribution limits | Subject to maximum premium rules | Holds any excess beyond allowable limits |
| Death benefit treatment | Paid to named beneficiary | Paid to owner or owner’s estate |
| Accessibility | Used for monthly deductions and cash value | Withdrawable separately, subject to rules |