Who should be the owner and beneficiary of your life insurance policy? The answer depends on tax and property considerations. A life policy is issued to an “applicant” who may be the insured, a spouse, a trustee of a trust, or another person having an insurable interest. The applicant designates the “owner” of the policy and the “beneficiary”. The owner is the person who has the right to change the beneficiary, borrow from the cash value, cancel the policy, and exercise other rights of ownership. The beneficiary is the person who receives the death benefit upon the death of the insured.
A major factor to be considered in deciding who should be the owner or beneficiary of a life policy is the potential impact of the federal estate tax. If the owner of the policy is the insured, upon death of the insured, the proceeds will be included in the estate of the insured for federal estate tax purposes. Also, if the beneficiary of the policy is the insured or the estate of the insured, the proceeds would be subject to federal estate tax. (Life insurance proceeds are exempt from state death taxation in Pennsylvania.)
To prevent insurance proceeds from being subject to federal estate tax upon death of the insured, the applicant generally designates the insured’s spouse, children, or the trustees of an irrevocable trust as the owner of the policy. If the owner is an individual, a contingent owner should be named who will become the owner if the original owner dies before the insured dies. If the owner is a trustee of a trust having a term longer than the life of the insured, there is no need to designate a contingent owner.
Once ownership is determined, the owner designates the beneficiary. If the beneficiary is an individual, a contingent beneficiary should be named in the event the primary beneficiary dies before the insured. No contingent beneficiary is needed if the beneficiary is a trust which will still be in existence after death of the insured.
What if the insurance policy is owned by a pension, profit sharing or other qualified plan? In all instances, the owner is the trustee of the plan. The beneficiary is sometimes the trustee of the plan and sometimes an individual designated by the participant, such as the participant’s spouse.
Life insurance is often used to fund the purchase of a business interest (corporation or partnership) under a Buy/Sell Agreement. Where the Buy/Sell Agreement provides for a corporation or partnership to purchase the interest of the deceased owner, the owner and beneficiary of the life policy is the corporation or partnership, as the case may be. Alternatively, if the arrangement provides for the surviving shareholders or partner to purchase the interest, those persons are the owners and beneficiaries of the policy.
Property and other non-tax factors can sometimes outweigh tax considerations. For example, the insured may want the death benefit be paid to the insured’s estate to pay a specific debt or mortgage so that a particular property will pass debt-free under the insured’s will. In such an instance, it may be that the estate is the proper beneficiary and estate tax considerations are secondary.
In summary, be cautious where the insured is the policy owner, or where the insured or the insured’s estate is the beneficiary. If the policy is owned by a pension or profit sharing plan, it is preferable for the beneficiary to be the person who will receive the proceeds, not the trustee of the plan. There is no general rule as to who should be the owner and beneficiary of a life policy in a buy/sell arrangement, and other property and tax factors need to be analyzed on a case by case basis.
A major factor to be considered in deciding who should be the owner or beneficiary of a life policy is the potential impact of the federal estate tax. If the owner of the policy is the insured, upon death of the insured, the proceeds will be included in the estate of the insured for federal estate tax purposes. Also, if the beneficiary of the policy is the insured or the estate of the insured, the proceeds would be subject to federal estate tax. (Life insurance proceeds are exempt from state death taxation in Pennsylvania.)
To prevent insurance proceeds from being subject to federal estate tax upon death of the insured, the applicant generally designates the insured’s spouse, children, or the trustees of an irrevocable trust as the owner of the policy. If the owner is an individual, a contingent owner should be named who will become the owner if the original owner dies before the insured dies. If the owner is a trustee of a trust having a term longer than the life of the insured, there is no need to designate a contingent owner.
Once ownership is determined, the owner designates the beneficiary. If the beneficiary is an individual, a contingent beneficiary should be named in the event the primary beneficiary dies before the insured. No contingent beneficiary is needed if the beneficiary is a trust which will still be in existence after death of the insured.
What if the insurance policy is owned by a pension, profit sharing or other qualified plan? In all instances, the owner is the trustee of the plan. The beneficiary is sometimes the trustee of the plan and sometimes an individual designated by the participant, such as the participant’s spouse.
Life insurance is often used to fund the purchase of a business interest (corporation or partnership) under a Buy/Sell Agreement. Where the Buy/Sell Agreement provides for a corporation or partnership to purchase the interest of the deceased owner, the owner and beneficiary of the life policy is the corporation or partnership, as the case may be. Alternatively, if the arrangement provides for the surviving shareholders or partner to purchase the interest, those persons are the owners and beneficiaries of the policy.
Property and other non-tax factors can sometimes outweigh tax considerations. For example, the insured may want the death benefit be paid to the insured’s estate to pay a specific debt or mortgage so that a particular property will pass debt-free under the insured’s will. In such an instance, it may be that the estate is the proper beneficiary and estate tax considerations are secondary.
In summary, be cautious where the insured is the policy owner, or where the insured or the insured’s estate is the beneficiary. If the policy is owned by a pension or profit sharing plan, it is preferable for the beneficiary to be the person who will receive the proceeds, not the trustee of the plan. There is no general rule as to who should be the owner and beneficiary of a life policy in a buy/sell arrangement, and other property and tax factors need to be analyzed on a case by case basis.
– Mike Beausang