OBERMAN LAW FIRM
Reducing Estate Taxes by Transferring Ownership of Your Life Insurance Policy
By Stuart J. Oberman
You can lower your beneficiaries' estate tax burden by making sure that you do not own your life insurance policy when you die.
Whether or not life insurance proceeds are included in the taxable estate depends on who owns the policy when the insured person dies. If the deceased person owned the policy, then the full amount of the proceeds are included in the federal taxable estate. However, if someone else owned the policy, then the proceeds are not included.
In order to avoid potential federal estate tax when you die, you may wish to transfer ownership of your life insurance policy to another person or entity. There are two ways to do it: (1) You can transfer ownership of your policy to any other adult, including the policy beneficiary; or (2) you can create an irrevocable life insurance trust, and transfer ownership to it.
Transferring Ownership to Other People: Transferring ownership of your policy to another person involves a trade-off: Once the policy is transferred, you will lose control over the policy, forever. You cannot cancel it or change the beneficiary.
IRS Rules Governing Life Insurance Transfers: The IRS has rules that determine who owns a life insurance policy when the insured person dies. Gifts of life insurance policies made within three years of death are disallowed for federal estate tax purposes. This means that the full amount of the proceeds are included in your estate, as if you remained the owner of the policy. The message here is obvious: If you want to give away a life insurance policy to reduce estate taxes, give the policy away as soon as is possible. (And then don't die for at least three years.)
The Nuts and Bolts of Transferring Ownership: You can give away ownership of your life insurance policy by signing a simple document, called an "assignment" or a "transfer". To do this, notify the insurance company, and use its form. There is normally no charge to make the change. Also, you usually have to change the policy itself to specify that the insured is no longer the owner. After the policy is transferred, the new owner should make any premium payments due. If you make payments, the IRS might contend that you're keeping an "incident of ownership" and include the proceeds in your federally taxable estate.
Method Two: Life Insurance Trusts: The second way to transfer a life insurance policy is to create an irrevocable life insurance trust and then hold the policy in trust. Once you transfer ownership of life insurance to the trust, you are no longer the owner, and the proceeds will not be part of your estate.
If you want estate tax savings from the life insurance trust, you must comply with the following strict requirements:
The life insurance trust must be irrevocable. If you have the right to revoke it, you will be considered the owner of the policy, and the proceeds will be subject to estate taxes.
You cannot be the trustee.
You must establish the trust at least three years before your death. If the trust has not existed for at least three years when you die, the trust is disregarded for estate tax purposes, and the policy proceeds are included in your taxable estate.
Stuart J. Oberman (Law Office of Stuart J. Oberman), an attorney in Loganville, Georgia, works with clients on a wide variety of transactional issues, including commercial, corporate and real estate law. For questions or comments regarding this article please call (770) 554-1400.
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