Steve Novak: Life Insurance Policy to Lower Estate Tax

Before we get started, you may not need to worry about transferring your life insurance policy unless your estate will be subject to the federal estate tax. As of 2017, only estates worth over $5.49 million are subject to any estate taxes, although this can be changed by Congress at any time.

If your estate could be subject to the estate tax, then it’s important to understand that only assets owned in your name at your death count towards the value of your estate. According to estate law, if you transfer your life insurance policy, when you pass away the proceeds will not be in your name and would therefore not be included in the value of your estate at your death.

In general, there are two ways that you can accomplish this goal. First, you can transfer ownership of the policy to another adult, even the named beneficiary. Second, you can create an irrevocable life insurance trust and transfer the policy to the ownership of the trust. Be aware, however, that if you get life insurance through your job, you may not be able to transfer ownership rights.

Transferring Ownership to Other Adults

Although it can be easier, transferring ownership of your life insurance policy to another adult has its drawbacks. Perhaps most significant is that once you transfer ownership you can’t change your mind or go back and alter the policy.

For example, if you transfer your life insurance policy to your best friend, but then have a falling out, you can’t get your life insurance policy back. These transfers tend to work well in situations when you transfer a policy to an adult child with whom you have a good relationship.

The Three-Year Rule

Whenever transferring ownership of life insurance policies, the three-year rule applies. Under this rule created by the IRS, if the transfer takes place within the three years before death and is made without any consideration, then the proceeds from the policy are counted in the estate for tax purposes. So, if you’re considering transferring ownership of your life insurance policy, you should do so sooner rather than later.

Other Applicable IRS Rules

There are other rules and regulations that the IRS follows to determine the ownership of life insurance policies for estate tax purposes, as discussed below.

Retaining Ownership

If a deceased person kept any “incidents of ownership” over the policy after a transfer, then the policy is still considered to be owned by the deceased at death and counted for estate tax purposes. Incidents of ownership exist where, after a transfer, the deceased retains the power to:

Cancel, surrender or convert the policy;
Use the policy as collateral to borrow money;
Change the named beneficiary on the policy; or
Select the method of payment for the policy (installments or a lump sum).

Gift Tax Concerns

Under current laws (as of 2017), any gift of more than $14,000 is subject to a gift tax. Therefore, if you transfer a life insurance policy that has a present value of more than $14,000, any amount over that will be taxed when the policy is paid out.

However, even with this tax, it’s still worthwhile to transfer the policy instead of keeping it within your estate. If your estate will already be subject to the estate tax, then the full amount of your life insurance policy will be included in your estate and be subject to the estate tax at your death. However, if you transfer the policy before your death, only the amount that the policy was worth at transfer will be taxed.

How to Transfer Life Insurance Policies

Much like giving other pieces of property, you can give away your life insurance policies either by signing a document called an “assignment of rights” or a “transfer”, or by transferring the policy into a life insurance trust. Let’s take a look at both options.

Assigning/Transferring Rights

Most life insurance companies have their own forms to transfer ownership, which are best to use to avoid confusion. You can request an assignment or transfer form directly from your life insurance company, but you may also have to change the policy to indicate that the insured is no longer the owner.

After the transfer has been completed, the new owner is responsible for making all premium payments. If you continue to make the payments on the policy, the IRS may view this as evidence that you are still the true owner and will count any life insurance proceeds in your estate for tax purposes.

In general, there are two types of life insurance policies that can be transferred. The first is a prepaid, single-payment policy. The upside of transferring this type of policy is that there are no premiums that the new owner must continually pay. However, if the policy is worth more than $14,000 when it is transferred, a gift tax will be assessed on your death. The second type is a policy that asks for yearly premium payments. If the policy is worth less than $14,000 each year, then there will be no gift tax assessed upon your death because you are giving a gift of less than $14,000 each year.

Life Insurance Trusts

In order to transfer your policy to a trust for estate tax purposes, you must create an irrevocable life insurance trust and then place the policy inside of the trust. After you transfer the policy, you are no longer the policy owner and the policy benefits will not be included in your estate.

There are a few reasons why this may be better than transferring ownership to another person. First of all, there may not be anyone that you trust to take ownership and control of the policy. Or, even if there is someone you trust, you may not want that person to incur the responsibility of paying the policy premiums.

In addition, by placing the life insurance policy inside of a trust, you may continue to have some control over the policy remotely. For example, you can set up the trust in such a way that you guarantee that the policy will continue to have its premiums paid while you are still alive by simply putting those conditions inside of the documents that create the trust.

There are three requirements in order to create a valid life insurance trust, which include:

The trust that you place your life insurance policy in must be irrevocable. This means that you will not have the right to revoke the trust. If you do, you are still considered the owner of the trust and it will be counted towards the value of your estate;
You cannot be the trustee of the trust; and
The trust must be created at least three years prior to your death (per the three-year rule).

Free Consultation with a Utah Estate Lawyer

If you are here, you probably have an estate issue you need help with, call Ascent Law for your free estate law consultation (801) 676-5506. We want to help you.