Ownership of Life Insurance:
Estate Planning
What are the ownership issues of
life insurance?
In estate planning, life insurance is
purchased for several reasons: (1) to provide cash to the insured's family for
daily living expenses, (2) to provide cash for potential death taxes and estate
expenses, and (3) to provide a shelter from income taxes (for beneficiaries),
potential estate taxes, or gift taxes (for insureds). In order to ensure that
your beneficiaries receive the maximum benefit from life insurance policies on
your life, you must structure ownership of these policies to minimize income and
potential estate taxes.
To avoid taxes, you must also properly
designate the beneficiaries.
Who should own your life
insurance?
Not you (the
insured), if your estate is more than the applicable exclusion amount
Life insurance proceeds from policies on your
life may be includable in your estate for estate tax purposes if you own the
policy outright, have any "incidents of ownership" in the policy at
the time of your death, or transfer ownership of the policy within three years
of your death. Inclusion of life insurance proceeds in your estate is not a
problem if your estate (including any includable life insurance proceeds) is
less than or equal to the applicable exclusion amount ($5,340,000 in 2014,
$5,250,000 in 2013). If your taxable estate (excluding any includable life
insurance proceeds) exceeds the applicable exclusion amount, you (the insured)
should consider alternate ownership of policies on your life.
"Incidents of ownership" is a legal
term that refers to the right of the insured to control the economic benefits
of the policy. This definition encompasses more than outright ownership of the
policy and includes the power: (1) to change the beneficiaries of the policy,
(2) to pledge the policy for a loan, (3) to surrender or cancel the policy, (4)
to assign the policy, or (5) to borrow against the surrender value of the
policy. A reversionary interest in a life insurance policy is also treated as
an incident of ownership in that policy and will result in inclusion of the
value of the policy in the insured's estate if the value of the reversionary
interest immediately before the insured's death exceeds 5 percent of the value
of the policy. A reversionary interest in a life insurance policy includes the
possibility that the policy or its proceeds may return to the decedent or his
or her estate or may be subject to a power of disposition (e.g., a power of
appointment) by the decedent.
Not your
spouse if you live in a community property state, if your estate is more than
the applicable exclusion amount
Community property states treat all types of
community property, including life insurance, as being owned one-half by each
spouse. Thus, one-half of a life insurance policy on your life that is owned by
your spouse may be includable in your estate for estate tax purposes. As
discussed above, this is not a problem if your estate (including any includable
life insurance proceeds) is less than or equal to the applicable exclusion
amount. However, if your estate (excluding any otherwise includable life
insurance policies) exceeds the applicable exclusion amount, you should
consider having ownership of the policy reside with someone other than your
spouse.
Another
individual
One person can own a policy insuring the life
of another. Proceeds of such a policy will not be includable in the insured's
estate, but the value of the policy may be includable in the owner's estate if
the owner dies before the insured.
Premiums may be paid by the owner, but not
from joint assets or community property belonging to the insured.
An
irrevocable trust
An irrevocable life insurance trust (ILIT) is
a type of trust that may be used to keep life insurance proceeds out of the
insured's estate for estate tax purposes. The trustee of the ILIT is the owner
of the policy, and the ILIT is the beneficiary. Upon the insured's death, the
proceeds are distributed to the ILIT and distribution to the beneficiaries of
the ILIT is made according to the terms of the trust agreement.
An ILIT is a complex estate planning tool and
must be properly created to be effective. If you are interested in taking
advantage of such a device, you should seek the assistance of an estate
planning professional in your state.
What if you transfer an existing
policy to another owner?
The proceeds
may be taxable if you die within three years after the transfer
If you own a policy on your life, you may
want to transfer ownership to another individual (e.g., to the beneficiary) to
avoid inclusion of the proceeds in your estate. Transferring ownership of a
policy is easy: Simply complete a change of ownership form provided by your
insurance company. Remember, though, that even if you transfer ownership of an
existing policy to another individual, it can be included in your estate if you
die within three years of the transfer.
CornerStone Financial
Whether your
nest-egg is worth millions or thousands,
You and your
family deserve it more than the government....
We are here to help you with all of your
financial and insurance needs. Our skilled professionals are licensed with
over 100 top name companies and can help you gain a better understanding of the
concepts behind insurance including investing, retirement and estate
planning. There are literally thousands of products to choose from,
but we can help pinpoint what is best for you and your situation. Please
do not hesitate to contact us if you have questions.
Contact:
Eric Tuttobene
President/CEO
CornerStone
Financial
(615) 427-8780
IMPORTANT DISCLOSURES
The
information presented here is not specific to any individual's personal
circumstances.
To the extent
that this material concerns tax matters, it is not intended or written to be
used, and cannot be used, by a taxpayer for the purpose of avoiding penalties
that may be imposed by law. Each taxpayer should seek independent advice from a
tax professional based on his or her individual circumstances.
These
materials are provided for general information and educational purposes based
upon publicly available information from sources believed to be reliable—we
cannot assure the accuracy or completeness of these materials. The information
in these materials may change at any time and without notice.
