Life insurance provides peace of mind to yourself and those you care about, but there are different ways to own life insurance. There are three distinct roles you need to know about with a life insurance policy:
The insured person;
The policy owner; and
The insured is the person who is covered by the policy. The person that purchases the life insurance policy is the policy owner. The beneficiary is the person or group of people, that will receive the benefits when the insured dies. Fortunately, you can transfer a life insurance policy to someone else if your circumstances or needs change.
Any adult or legal entity can own a life insurance policy as long as there is mutual consent and insurable interest. An insurable interest exists when the death of the insured person would negatively impact someone else. Typical examples are spouses, parents and children, and business owners and key employees. When you "own" a life insurance policy, you have full responsibility and control over that policy. Some of the things you can do as the owner include:
Determine the length and amount of coverage;
Select the beneficiaries or change them, if necessary;
Choose how beneficiaries will receive the policy proceeds;
Borrow against the cash value of a whole life policy;
Cancel or surrender your policy; and
Transfer ownership of your policy.
It's not uncommon for a person to be both the owner and the insured on a life insurance policy. This arrangement keeps things simple. It makes sense because you are providing financial protection for your loved ones after you are gone. But there may be situations in which someone else will own your life insurance policy.
If you are the owner of your policy, the policy proceeds will be part of your taxable estate for federal tax purposes should your estate exceed the excluded amount. The exclusion amount for 2020 is $11.58 million per person, and these exclusions expire in 2025. State estate taxes are additional, and the amount you'll pay varies by state.
While the estate tax rules might be troubling, they don't apply to everyone. First, most people won't have estate values that reach past the exclusion amount. Next, if your beneficiary is your spouse and you own your life insurance policy, the marriage deduction law states that the value of your estate won't include policy proceeds.
As long as another person or entity has an insurable interest in you, they can own your policy. Specifically, some of the parties that might hurt financially if you die include:
Your Spouse Spouses might own life insurance policies on each other for peace of mind. In some cases, one spouse sees the value of life insurance, and the other doesn't.
Your Children Adult children can own a life insurance policy on their parents if they would suffer financially upon a parent's death. This might apply if a parent owns a business.
Your Parents Your parents might own life insurance on you for two reasons. First, it would cover your burial expenses should you pass away before them. Second, some riders will allow them to transfer ownership of that policy later.
Your Boss or Business Partners It's not uncommon for business owners and partners to protect their financial investment in a business by holding life insurance on a "key person."
If you own your life insurance policy, you can transfer it to someone else pretty easily. The process only requires that you fill out a form and send it to your life insurance company. If the form isn't available on the website, you can call the insurer and request a copy. To transfer a life insurance policy to someone else, you'll need the following information about the new owner:
Social security number
Relationship to the insured
An organization or trust can also own a life insurance policy. If you are transferring your policy to one of these entities, you'll need some additional information, including the name and type of business and the name of the trustees.
While it might be simple to transfer ownership of your life insurance policy to someone else, you should consider the potential financial implications of doing so first.
The IRS doesn't want people to transfer ownership of their life insurance policies just before dying to avoid taxes. Under Code Section 2035, the insured on the policy must survive for three years after the transfer of ownership or the policy proceeds will be included in the deceased's estate and be subject to estate taxes where applicable. The best way to avoid this is to sell a life insurance policy to a trust, which is an action not covered by Section 2035.
Anytime you give someone money over the annual exclusion limit, you are subject to the federal gift tax. As of 2018, you can gift up to $15,000 without paying taxes. If you transfer a cash value life insurance policy that is worth more than this, it will be considered a taxable give. Again, you can avoid the gift tax by selling them the policy.
When you own a life insurance policy, it makes sense to review your policy on occasion to ensure that it reflects your wishes and has the right beneficiaries listed. Some common life events that should trigger a review of your life insurance policy and needs include:
You get married or divorced;
You have a baby or adopt a child;
You open or close a business;
You change jobs or move; and
You purchase a home, other property, or something else of value.
While you may be able to transfer the ownership of your life insurance policy by filling out and signing a simple form, you should approach such a change deliberately. Speak with an expert today!