The benefits of shifting ownership of life insurance to save estate taxes are most easily and certainly obtainable if a party who has an insurable interest in the insured’s life purchases the policy and pays all the premiums and is the beneficiary of the proceeds when the insured dies. That party should be someone other than the insured or the insured’s estate. Since the proceeds are not paid to or for the benefit of the estate of the insured and because the insured owned no incidents of ownership over the policy and because there was no transfer of the policy within three years of death, there will be no estate tax inclusion.
The second best alternative is to transfer existing policies by gift to the insured’s spouse or some other trusted person or, the most preferable method when the combined estates exceed the unified credit exemption equivalent, transfer the policies to an irrevocable life insurance trust. Removing the proceeds from the insured’s gross estate in this manner not only lowers the overall tax burden but also provides a means of creating estate liquidity (cash to pay the decedent’s debts, taxes and other expenses of estate administration). The recipient of the policy proceeds can make fully secured interest bearing loans to the estate’s executor or purchase assets from the estate. This gives the estate cash and helps assure that desired assets remain within the family unit.
Liquidity could be provided by the direct purchase of life insurance by the grantor. However, the incredible advantage of third party ownership of life insurance is that it provides liquidity for the estate without causing inclusion of the life insurance proceeds in the client’s estate (or, where the insurance is owned by a third party such as the insured’s child or an irrevocable life insurance trust, without causing inclusion in the estate of the client’s spouse).
If the policy is originally owned or transferred to the insured’s spouse who is also the premium payor and beneficiary, the estate tax will be delayed until the death of the surviving spouse. Assuming the insured’s spouse survives the insured, this means that money that otherwise would have been paid in federal estate taxes can instead be used to provide support for the spouse and children. To the extent used by the surviving spouse, those proceeds will never be subject to federal estate tax.
If the policy is originally owned or transferred to the insured’s children, then no estate tax is imposed until the next generation and even then only to the extent the children have not used the money.
Reproduced with permission. Copyright The National Underwriter Co. Division of ALM