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Life insurance provides peace of mind to your family members, but it can also mean a big tax bill for your children or other heirs. If you already know that you’re going to be subject to federal estate tax after you die, transferring your life insurance policy over to someone else can allow your beneficiaries to sidestep some of the cost. Below you’ll find helpful information you need to know about life insurance transfers. And if you’re looking for additional expert assistance, SmartAsset’s free tool can match you with a financial advisor.
There are two basic ways to remove a life insurance policy from your taxable estate. The first is to place it in an irrevocable trust. A trustee takes control of the plan and makes sure premiums are paid and money is divided up according to your wishes after you’re gone.
The other option is to transfer ownership of the money directly to someone else. The process is pretty straightforward and usually involves filling out assignment or transfer forms with your insurer. Once you transfer the policy over, you no longer have any control over it so you can’t change the beneficiaries or increase the coverage limit.
You might not want to transfer the policy to your spouse if you’re trying to minimize your tax liability. That’s because your husband or wife could eventually be subject to high estate taxes. The better choice could be to transfer it to an adult child or another relative.
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In the eyes of the IRS, timing is everything when it comes to life insurance policy transfers. If you transfer a policy and die within three years of the transfer date, it’s still considered part of your estate for taxation purposes. If you’re concerned that your health might shorten your life span, it’s a good idea to transfer the policy sooner rather than later to avoid the potential tax implications.
The IRS also has a stipulation about the “incidents of ownership” which could make a transfer null and void. Basically, if you still have any legal rights to the policy – such as the ability to switch beneficiaries or borrow against the policy – you’re still technically considered its owner. In that case, the estate tax would still apply.
Federal gift tax applies any time you give someone money in excess of the annual exclusion limit. As of 2022, you could gift up to $16,000 to someone without incurring the gift tax. If you transfer a cash value life insurance policy to someone and it’s worth more than the exclusion limit, it’s considered a taxable gift.
If the new owner of the policy is required to pay ongoing premiums to maintain it, you can still gift them up to $16,000 to cover the cost without a penalty. If you do have to pay gift tax on a transfer, it’s generally much less than what you’d pay in estate taxes if you held onto the policy.
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When you’ve managed to build up a decent amount of wealth, you don’t want to see a big chunk of it get carried off by Uncle Sam. If done properly, transferring your life insurance policy can keep more of your hard-earned money in the hands of your loved ones.
Photo credit: ©iStock.com/SaferTim, ©iStock.com/Pgiam, ©iStock.com/Andy445
Rebecca Lake, CEPF®Rebecca Lake is a retirement, investing and estate planning expert who has been writing about personal finance for a decade. Her expertise in the finance niche also extends to home buying, credit cards, banking and small business. She's worked directly with several major financial and insurance brands, including Citibank, Discover and AIG and her writing has appeared online at U.S. News and World Report, CreditCards.com and Investopedia. Rebecca is a graduate of the University of South Carolina and she also attended Charleston Southern University as a graduate student. Originally from central Virginia, she now lives on the North Carolina coast along with her two children. Rebecca also holds the Certified Educator in Personal Finance (CEPF®) designation.
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