Planners must be constantly aware of the gift tax implications of transactions involving life insurance. Gifts of life insurance, as opposed to gifts of income-producing property, are favored vehicles for many reasons. These include:
- A gift of life insurance may increase the donor’s spendable income since, after the gift, the donee often pays the premiums and the donor then can spend, invest, or give away the money that otherwise would have been paid in life insurance premiums. Conversely, a gift of income producing property will deprive the donor of the net after tax income from that property.
- The donee is less inclined to surrender a policy for its cash value than to dispose of income-producing property. This increases the probability that the policy, and therefore the proceeds, will be available to the beneficiaries. The likelihood of achieving the client’s objectives (enhancement of the beneficiary’s financial security or creation of a source of liquidity for the client’s estate) will be met.
- The gift tax cost of the transfer, when the gift is life insurance, is relatively low since essentially only the replacement value, rather than the face amount, is subject to gift tax. When income-producing property is given, the entire fair market value is subject to gift tax. In other words, for the same gift tax cost a much larger amount can be excluded from a client’s gross estate. For example, a ten-year-old whole life policy that will generate $1,000,000 of death benefit could be removed from a client’s estate at the cost of a relatively low gift tax based on the policy’s value at the date of the gift.
- There is no gain for income tax purposes when a life insurance policy matures at death, even if that policy was obtained by gift. If any other type of property is given away, the recipient takes as his basis the donor’s basis (with certain adjustments). In other words, the donor’s basis is carried over from the donor to the recipient. Thus, no step up from the donor’s basis is allowed to the donee on a gift except for perhaps a portion of any gift tax paid on the transfer. So, a gift of property other than life insurance results in a carryover basis and, upon a later sale by the donee, the entire gain inherent in the property must be recognized.
- The client’s personal financial security is diminished only by the transferred cash value and even this potential problem can be minimized by a carefully measured pretransfer loan.
- A gift of life insurance may be a way to assure children of a first marriage of financial security and a share of their parent’s wealth in the event of a second marriage.
- Assume a client has a large estate and wants to provide children with an amount greater than the unified credit equivalent during the lifetime of his spouse. The client is going to leave all but the unified credit equivalent to his spouse, but doesn’t want his children to have to wait until the surviving parent dies to receive their inheritance. A gift of life insurance from the client to the children more than three years before the client’s death would help assure the achievement of the multiple goals.
Reproduced with permission. Copyright The National Underwriter Co. Division of ALM