Prevent a Family Fued…

Contrary to some opinions, life insurance is closer to rocket science than the buying of apples. It seems that most people may be making a mistake when they buy life insurance, because they do not understand all that it means to be a life insurance policy owner. So, what does it mean to own a life insurance policy?

If you have the title to your car, you own that car. The title cannot be transferred or sold without your consent. As the owner, you have full responsibility for that car. Likewise, if you have the title to your home, you own your home. Your home cannot be sold without your consent. Your home cannot be used as collateral without your consent. As the owner, you control what happens to your home. If you own a life insurance policy, you control it. It is an asset just like your car and home. You, as the owner, have the legal and contractual right to make changes to the policy, to use it as collateral for a loan and to sell or give it away. All rights vest in you as long as you are the owner.

Can the owner and insured be the same party? Can they be different parties? Generally, policies for the benefit of one’s family have been owned by the insured. On the other hand, when a policy is taken out by an employer for the benefit of the employer (usually referred to as “key person insurance”), the employer is the owner and the beneficiary. Could it be that most insurance agents have been wrong in having the insured as the owner of the policy?

The owner of the policy should be determined by the purposes of the policy and the competency of the beneficiaries and their relationship to the insured. The best way I know of defining this is by using examples. Let’s take a look at some situations and briefly discuss why we would choose one arrangement over the other.

Young, Single, Whole Life Single young adult knowledgeable about the saving-to-spend function of whole life insurance: This insured should be the owner. Our presumption here is that a young single can change the ownership of the policy to the future spouse at the same time as designating the spouse as beneficiary.

Beneficiary as Owner Married couple, with both in agreement on how to use the policy: The beneficiary should be the owner. There is a couple of considerations here. The first is the fact that the nonowner insured is most likely to be in agreement with any action that the owner-beneficiary wishes to take. On the other hand, in the event of a divorce, if the life insurance policy is owned by the beneficiary, it would be protected from inappropriate termination by the insured.

ILIT as Owner Married couple, with some differences in opinion as to financial perspectives: The insured is the logical choice, because in this case the insured may be concerned that the intended beneficiary might abuse or terminate the policy. And it might be the insured’s opinion that the beneficiary should receive a monthly income, rather than the entire death benefit all at once.

Scenario No. 4 Executive or investor with assets near to or in excess of $1 million: In this case, life insurance trust (ILIT). When a person dies leaving an estate greater than the established excludable amount to a non-spousal relative, the excess will be subject to the federal estate tax. A life insurance policy owned by the insured in this example would lose 35 percent of its value to the IRS, since ownership by the insured makes the policy part of the deceased’s estate.

An ILIT is a legal entity that is the owner and primary beneficiary of the life insurance policy. By having the policy owned and paid for by the ILIT, the insured has no ownership control of the policy. Therefore, the policy is not part of the deceased’s estate.

With the ILIT as the primary beneficiary, the intended recipients of the proceeds would be the beneficiaries of the ILIT. The premiums paid by the ILIT typically are funded by gifts from the insured and the insured’s spouse that are paid into the trust. So as long as these gifts do not exceed the annual per person maximum allowed by federal law (per the beneficiaries of the ILIT), these would not be subject to a gift tax, and neither the premiums paid from the monetary gifts or the life insurance death benefit would be charged the federal estate tax.

Contingent Beneficiaries Parents, with minor children as contingent beneficiaries: Spouses as owner/beneficiaries with a living trust for the benefit of their children. In California, where this author resides, children under the age of 18 are not entitled to receive the proceeds from a life insurance policy. In order for those under age 18 to benefit from policies on the parents, it is necessary to have a trustee administer the funds created by the death of the parents. The living trust is created to receive the proceeds from a life insurance policy. A trustee is appointed in the trust document, whose responsibility is to follow trust instructions for the benefit of the minor beneficiaries. Unlike the ILIT, during the lifetime of the creator of the trust, its instructions can be changed.

A Senior Scenario Older single adult: Adult offspring as owner and beneficiary. In the event that an insured needs assistance to cover the cost of long-term care, life insurance owned by a senior is vulnerable to Medicaid rules. If the beneficiary owns the policy, the policy is out of reach of Medicaid. Care should be taken to change ownership to the beneficiary early enough to prevent a look-back period that would void the attempt to qualify for Medicaid. These are some of the issues that affect the decision as to who should be the owner. Applying these examples to other situations may help clarify who the owner should be. Individual considerations might alter the judgment of the client and agent, but simply having become familiar with these options should make the process easier.

Willard R. Brumbaugh, LUTCF,  

of Victorville, Calif., is a member of the National Association of Insurance and Financial Advisors and a past Life Under writing Training Council (LUTC) chairman. 

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