The amount of the gift tax will be far less than the amount of estate tax that would be due if your policy remained in your name and in your estate. This is because the policy proceeds are considerably more than the value of the policy while the insured is alive.
The client transfers ownership of his universal life insurance policy to his son. The value of the policy when he transfers it is $27,000. So there is $13,000 of gift tax impact. The face amount is $300,000 on death it now passes outside the client’s estate and income tax free to the beneficiary.
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 it’s form. There's 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 still own the policy and include it in your estate.
A more complex approach (attorney drafts the trust)
The second possible 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're no longer the owner, and the proceeds won't be part of your estate.
Why create a life insurance trust?
- You want to get the proceeds out of your taxable estate.
- You want to exert legal control over the policy and avoid the risks of having an insurance policy, on your life, owned by someone else.
- You don't trust the beneficiary’s to pay policy premiums.
The single client has two children in their twenties, who will be the beneficiaries. Neither is sensible with money. The estate is worth $7,000,000. The universal life policy has a cash value of $100,000 and will pay $1,000,000 at death. The client wants to be sure the estate will not be liable for additional estate taxes and does not trust anyone to pay the premium. The client decides to create a life insurance trust and transfers ownership of the life insurance policy to the trust. There will be an $86,000 impact on the clients’ lifetime exemption. After death, the trustee will handle the money for the children under the terms of the trust document.
To make this work…
• The trust must be irrevocable.
• The client can make annual gifts to the trust to pay premiums.
• The client cannot be the trustee.
• It must be established at least 3 years before death.
• An attorney must draft the trust.
When recommending life insurance think outside the “client box”. Life insurance owned by relatives or a trust could result in a tax planning home run.
For Financial Professional Use Only. Not For Use With The Public.