Who Should Own Your Life Insurance Policy

Who Should Own Your Life Insurance Policy?

Several years ago, you took out a life insurance policy on your life and named your spouse as the owner and primary beneficiary. Makes perfect sense, doesn’t it?

When completing the life insurance paperwork, you may have relied upon the agent who sold you the policy. Or you may have just figured that because the policy insures your life that it’s logical to conclude your spouse will survive you so she should own the policy.

Except that’s not how you should title the ownership of the policy.

Suppose, for example, that you survive your spouse, and you want to change the beneficiary of the policy on your life. You can’t change the beneficiary of the policy because you don’t own it. Your spouse owned the policy. She was the only one who had the legal right to change the beneficiaries. On her death, her Last Will & Testament leaves you everything, including the insurance policy, but in order to transfer ownership from her estate to you a probate process would be required.

That probate process could be very time consuming and expensive.

So how should you title the ownership of life insurance policies? Everyone’s situation will be different, so as a general rule you should tell your estate planning attorney about any life insurance policies that you own. He or she can then counsel you on the most advantageous way to designate the ownership and beneficiaries for that policy.

Important information that your attorney will need to counsel you includes not only the amount of the death benefit, but also the current cash surrender value, whose life the policy insures, who owns the policy, the amount of the annual premium payments, and the names of the primary and contingent beneficiaries.

Another important factor when deciding who should own the life insurance policy is the tax consequence associated with the policy. While life insurance is usually income tax free to the recipient, the amount of the policy is included in the deceased owner’s estate for federal estate tax purposes. So if Glenn owns a $2 million life insurance policy on his life that pays to his children, that $2 million death benefit increases the value of Glenn’s estate. That could, conceivably, create a taxable estate where none would otherwise exist.

If estate tax is not a concern even when adding the value of the life insurance to one’s estate, then, generally speaking it is a good idea for the person who is the insured to own the policy on his or her life. The transfer of the policy to change beneficiaries is not an issue, because when the insured dies, then the policy pays the death benefit to the beneficiaries. In other words, the policy will never continue on beyond the insured’s life, since by definition it pays the death benefit when he dies.

If, on the other hand, estate tax could be a concern in the insured’s estate, then several other options should be considered. One option is to create an irrevocable life insurance trust (ILIT) to own the policy. By having an ILIT own the policy (provided the insured survives the transfer to the ILIT for a period of three years), the death benefits could avoid taxation. The transfer to the ILIT, however, could be a taxable gift, depending upon the cash surrender value of the policy at the time of transfer. Moreover, the ongoing premium payments could be taxable gifts so the ILIT should be constructed in such a manner as to take advantage of the gift tax annual exclusion amounts (currently $15,000 per beneficiary annually). You may have heard of “Crummey powers” that are used to that end.

Another viable option includes having the insured’s revocable living trust own the policy and also be the designated beneficiary of the policy. Here, the ownership and beneficiary designation could be constructed to take advantage of the deceased’s federal estate tax exemptions if they are needed, while the revocable trust that receives the death benefits would then benefit the deceased’s spouse and children. The trust could also include provisions designed to protect the benefits from creditors or predators of the surviving spouse and children.

Yet another option is to create a revocable trust that the insured’s children own. This strategy is used when the children are the intended beneficiaries of the policy but the family’s goals include minimizing estate tax while preserving flexibility and avoiding probate.

As one might fathom from this short article, there are several good strategies to consider when considering the owner and beneficiary of a life insurance policy. As with many estate planning decisions, it is good practice to take one’s time and consider all alternatives since mistakes can be costly and are easily avoided with a little forethought.

©2020 Craig R. Hersch. Learn more at www.sbshlaw.com

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