Advanced Underwriting Consultants

Ask the Experts – November 4

Ask the Experts!

The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers.  Here’s the question of the day.

Question:  My client is the insured on a life insurance policy, but not the owner of the policy. Will the death benefits be subject to estate taxes?

Answer: It depends.

The general rule under Code Section 2042 is that if the insured either (1) is the owner (and beneficiary) of his life insurance policy, or (2) has any right to the economic benefits of the policy—referred to as “incidents of ownership”—then the proceeds will be included in the insured’s estate at his death.

Incidents of ownership include the power of the insured to—

  • Directly or indirectly change the beneficiary of the policy;
  • Surrender or cancel the policy;
  • Assign or revoke assignment of the policy;
  • Pledge the policy as collateral for a loan; and
  • Obtain a loan from the carrier on the surrender value of the policy.

Therefore, even if the insured does not directly own the policy, if he enjoys the incidents of ownership, he must include such proceeds in his estate.

Incidents of ownership may be attributed to the insured indirectly. For example, if the insured holds more than half of the voting stock in a corporation that owns a policy on the insured’s life, the proceeds from the policy will be included in the insured’s estate unless the proceeds are paid directly or indirectly to the corporation. See Treas. Reg. Sec. 20.2042-1(c)(6).

If your client is concerned with reducing his estate at death, he should make sure his policy not only names another as beneficiary, but it should also avoid any incidents of ownership, which encompass much more than strict beneficiary rights to the policy proceeds.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day.