Ask the Experts!

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

Question: I’ve heard that having a third party owner of a life policy name a different third party the beneficiary can create a tax problem.  Can you explain that?

Answer: In general, if the insured owns a life insurance contract, the insured can name anyone he wants the beneficiary of the contract, while still keeping the death proceeds income tax free.

If a third party owns the contract, the third party must name itself the beneficiary of the policy.  If there’s a mismatch, it creates tax trouble.

For example, say that Ben’s company owns a life insurance contract on Ben’s life.  The company names Ben’s wife the beneficiary of the policy’s death benefit.  At Ben’s death, the death proceeds will be treated as a taxable distribution to Ben’s wife.  See Golden v. Comm., 113 F.2d 590 (3rd Cir. 1940) and Revenue Ruling 61-134.

In a personal situation, say that Cathy owns a life policy on her husband Paul’s life.  Cathy decides that in the event of Paul’s death, she doesn’t need the death proceeds.  Cathy names their son Brandon as the beneficiary.

At Paul’s death, Cathy will be considered to be making a taxable gift to Brandon.  While that doesn’t expose the death proceeds to income taxes, it does make them subject to gift taxes.  See Goodman v. Comm., 156 F.2d 218 (2d Cir. 1946).

The rule of thumb for the professional advisor is that if a third party owns a life contract, the same third party should be the beneficiary.

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.