Insurance Broker | Financial Consultant, Lawrence Insurance Consulting, Southern New Jersey
life insurance proceeds are payable to an insured’s estate, is their value includable in the insured’s estate-
The entire value of the proceeds must be included in the insured’s gross estate even if the insured possessed no incident of ownership in the policy, and paid none of the premiums.[1] But proceeds payable to an executor in his or her individual capacity rather than as executor for the insured’s estate were not treated as payable to the insured’s estate by the Tax Court.[2]
[1] .IRC Sec. 2042(1); Est. of Bromley v. Comm., 16 BTA 1322 (1929).
[2] .Est. of Friedberg v. Comm., TC Memo 1992-310.
When are life insurance proceeds that are payable to a beneficiary other than the insured’s estate includable in the insured’s estate?
Proceeds are includable in an insured’s gross estate if the insured legally possessed and could legally exercise any incidents of ownership at the time of the insured’s death. It does not matter that the insured did not have possession of the policy and therefore was unable to exercise his or her ownership rights at the time of his or her death,[1] or that the insured was unable as a practical matter to effect any change in the policy because the policy was collaterally assigned.[2]
The proceeds are includable even if the insured cannot exercise his or her ownership rights alone, but only in conjunction with another person.[3] It has been held that an insured did not possess incidents of ownership where the insured had paid no premiums, did not regard the policy as the insured’s own, and had made an irrevocable designation of beneficiary and mode of payment of proceeds.[4] But even if the proceeds are payable to a beneficiary other than the insured’s estate, and the insured possesses no incidents of ownership in the policy, the proceeds are nevertheless includable in the insured’s gross estate if they are receivable for the benefit of the insured’s estate. Even though the insured retains no incidents of ownership in the policy, the proceeds may be includable in the insured’s estate if the insured has transferred the policy within three years before the insured’s death.
[1] .Comm. v. Est. of Noel, 380 U.S. 678 (1965).
[2] .Est. of Goodwyn v. Comm., TC Memo 1973-153.
[3] .IRC Sec. 2042(2); Goldstein’s Est. v. U.S., 122 F. Supp. 677 (Ct. Cl. 1954).
Can an insured remove existing life insurance from his or her gross estate by an absolute assignment of the policy?
Yes, assuming the insured lives for at least three years after the assignment, the insured assigns all incidents of ownership, and the assignee is not legally obligated to use the proceeds for the benefit of the insured’s estate.[1]
If the form of the assignment reserves any incidents of ownership to the insured, the proceeds may be included in the insured’s gross estate despite the insured’s clear intention to transfer all ownership rights.[2] It has been held that where the insured had paid no premiums and had never treated the policy as his or her own, the insured’s irrevocable designation of beneficiaries and mode of payment of proceeds was an effective assignment of all of the insured’s incidents of ownership in the policy.[3] The amount of any premiums paid on the assigned policy by the insured may be included to the extent they are paid within three years of death.
A reversionary interest in a policy is an incident of ownership if, immediately before the insured’s death, the value of the reversionary interest is worth more than five percent of the value of the policy.[4] The insured will have no such reversionary interest, however, if the policy is purchased and owned by another person, or if the policy is absolutely assigned to another person by the insured. Regulations state that the term “reversionary interest” does not include the possibility that a person might receive a policy or its proceeds by inheritance from another person’s estate, by exercising a surviving spouse’s statutory right of election, or under some similar right. They also state that, in valuing a reversionary interest, interests held by others that would affect the value must be taken into consideration. For example, a decedent would not have a reversionary interest in a policy worth more than five percent of the policy’s value, if, immediately before the decedent’s death, some other person had the unrestricted power to obtain the cash surrender value of the policy; the value of the reversionary interest would be zero.[5]
An insured was treated as holding a reversionary interest in a policy held in a trusteed buy-sell arrangement where the insured was considered to have transferred the policy to the trust and retained the right to purchase the policy for its cash surrender value upon termination of the buy-sell agreement.[6] However, a policy held in a trusteed buy-sell arrangement would not be includable in an insured’s estate under IRC Section 2042 where (1) proceeds would be received by a partner’s estate only in exchange for purchase of the partner’s stock, and (2) all incidents of ownership would be held by the trustee of the irrevocable life insurance trust.[7]
[1] .Treas. Regs. §§20.2042-1(b)(1), 20.2042-1(c)(1); Lamade v. Brownell, 245 F. Supp. 691 (M.D. Pa. 1965).
[2] .Est. of Piggott v. Comm., 340 F.2d 829 (6th Cir. 1965).
Co-Founder, Coastal Financial Partners Group, California
Life insurance proceeds can avoid probate. Having a named beneficiary rather than the estate of the insured allows the property to pass by contract directly to heirs without the need for probate. Its effect generally supersedes anything that a will or trust might say. If there is no beneficiary, the proceeds default to the estate which results in probate.
It is also a good idea to consider naming at least one contingent (backup) beneficiary and have the insurer confirm the identity of all beneficiaries at least every three years. Clients are often surprised to find they have existing policies with beneficiaries who are deceased which means the estate would get the proceeds and be subjected to probate.
One of the benefits of Life Insurance is that it can help a family plan to bypass probate. A properly structured policy with a correct beneficiary designation to a person or entity that is not the deceased's estate will bypass probate. Many families are happy to hear this and use Life Insurance to control how and where their legacy is transferred without the work probate entails.
Jerry made a great point above about reviewing beneficiary designations on a regular basis. (Especially on older policies - or other accounts that have beneficiary designations, like IRA's and 401(k)s). Beneficiaries can be updated and changed to help maintain the benefit of bypassing probate.
Not usually. As long as the policy has a named beneficiary who is alive when the insured dies the proceeds will normally skip the probate process.
If there are no living beneficiaries when the insured dies, then the proceeds are paid to the insured's estate at which time the funds would need to go through the probate process in order to be distributed to heirs.
Keep in mind that proceeds paid to a deceased beneficiary could end up in that beneficiary's estate and would need to go through the probate process in order for that beneficiary's heirs to receive the proceeds.
Life insurance does not go into probate if the beneficiary is a person, trust or entity other than the estate. If the beneficiary is the estate, if all beneficiaries are deceased, or if there is no beneficiary named on the policy, the insurance proceeds will be paid to probate court, where fees will be deducted. Life insurance with a designated beneficiary avoids all that.
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The entire value of the proceeds must be included in the insured’s gross estate even if the insured possessed no incident of ownership in the policy, and paid none of the premiums.[1] But proceeds payable to an executor in his or her individual capacity rather than as executor for the insured’s estate were not treated as payable to the insured’s estate by the Tax Court.[2]
[1] .IRC Sec. 2042(1); Est. of Bromley v. Comm., 16 BTA 1322 (1929).
[2] .Est. of Friedberg v. Comm., TC Memo 1992-310.
When are life insurance proceeds that are payable to a beneficiary other than the insured’s estate includable in the insured’s estate?
Proceeds are includable in an insured’s gross estate if the insured legally possessed and could legally exercise any incidents of ownership at the time of the insured’s death. It does not matter that the insured did not have possession of the policy and therefore was unable to exercise his or her ownership rights at the time of his or her death,[1] or that the insured was unable as a practical matter to effect any change in the policy because the policy was collaterally assigned.[2]
The proceeds are includable even if the insured cannot exercise his or her ownership rights alone, but only in conjunction with another person.[3] It has been held that an insured did not possess incidents of ownership where the insured had paid no premiums, did not regard the policy as the insured’s own, and had made an irrevocable designation of beneficiary and mode of payment of proceeds.[4] But even if the proceeds are payable to a beneficiary other than the insured’s estate, and the insured possesses no incidents of ownership in the policy, the proceeds are nevertheless includable in the insured’s gross estate if they are receivable for the benefit of the insured’s estate. Even though the insured retains no incidents of ownership in the policy, the proceeds may be includable in the insured’s estate if the insured has transferred the policy within three years before the insured’s death.
[1] .Comm. v. Est. of Noel, 380 U.S. 678 (1965).
[2] .Est. of Goodwyn v. Comm., TC Memo 1973-153.
[3] .IRC Sec. 2042(2); Goldstein’s Est. v. U.S., 122 F. Supp. 677 (Ct. Cl. 1954).
[4] .Morton v. U.S., 29 AFTR 2d 72-1531 (4th Cir. 1972).
Can an insured remove existing life insurance from his or her gross estate by an absolute assignment of the policy?
Yes, assuming the insured lives for at least three years after the assignment, the insured assigns all incidents of ownership, and the assignee is not legally obligated to use the proceeds for the benefit of the insured’s estate.[1]
If the form of the assignment reserves any incidents of ownership to the insured, the proceeds may be included in the insured’s gross estate despite the insured’s clear intention to transfer all ownership rights.[2] It has been held that where the insured had paid no premiums and had never treated the policy as his or her own, the insured’s irrevocable designation of beneficiaries and mode of payment of proceeds was an effective assignment of all of the insured’s incidents of ownership in the policy.[3] The amount of any premiums paid on the assigned policy by the insured may be included to the extent they are paid within three years of death.
A reversionary interest in a policy is an incident of ownership if, immediately before the insured’s death, the value of the reversionary interest is worth more than five percent of the value of the policy.[4] The insured will have no such reversionary interest, however, if the policy is purchased and owned by another person, or if the policy is absolutely assigned to another person by the insured. Regulations state that the term “reversionary interest” does not include the possibility that a person might receive a policy or its proceeds by inheritance from another person’s estate, by exercising a surviving spouse’s statutory right of election, or under some similar right. They also state that, in valuing a reversionary interest, interests held by others that would affect the value must be taken into consideration. For example, a decedent would not have a reversionary interest in a policy worth more than five percent of the policy’s value, if, immediately before the decedent’s death, some other person had the unrestricted power to obtain the cash surrender value of the policy; the value of the reversionary interest would be zero.[5]
An insured was treated as holding a reversionary interest in a policy held in a trusteed buy-sell arrangement where the insured was considered to have transferred the policy to the trust and retained the right to purchase the policy for its cash surrender value upon termination of the buy-sell agreement.[6] However, a policy held in a trusteed buy-sell arrangement would not be includable in an insured’s estate under IRC Section 2042 where (1) proceeds would be received by a partner’s estate only in exchange for purchase of the partner’s stock, and (2) all incidents of ownership would be held by the trustee of the irrevocable life insurance trust.[7]
[1] .Treas. Regs. §§20.2042-1(b)(1), 20.2042-1(c)(1); Lamade v. Brownell, 245 F. Supp. 691 (M.D. Pa. 1965).
[2] .Est. of Piggott v. Comm., 340 F.2d 829 (6th Cir. 1965).
[3] .Morton v. U.S., 29 AFTR 2d 72-1531 (4th Cir. 1972).
[4] .IRC Sec. 2042(2).
[5] .Treas. Reg. §20.2042-1(c)(3).
[6] .TAM 9349002.
[7] .Let. Rul. 9511009.
It is also a good idea to consider naming at least one contingent (backup) beneficiary and have the insurer confirm the identity of all beneficiaries at least every three years. Clients are often surprised to find they have existing policies with beneficiaries who are deceased which means the estate would get the proceeds and be subjected to probate.
Jerry made a great point above about reviewing beneficiary designations on a regular basis. (Especially on older policies - or other accounts that have beneficiary designations, like IRA's and 401(k)s). Beneficiaries can be updated and changed to help maintain the benefit of bypassing probate.
If there are no living beneficiaries when the insured dies, then the proceeds are paid to the insured's estate at which time the funds would need to go through the probate process in order to be distributed to heirs.
Keep in mind that proceeds paid to a deceased beneficiary could end up in that beneficiary's estate and would need to go through the probate process in order for that beneficiary's heirs to receive the proceeds.