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What Is It?

The transfer-for-value rule is an exception to the general rule that death benefits from a life insurance policy aren't included in the income of the policy's beneficiary. It applies when a policyholder transfers the policy for value during his or her lifetime and receives valuable consideration in return.

The General Rule: Section 101 (A) (1) of the Internal Revenue Code

As a general rule, the beneficiary of a life insurance policy can receive the death benefits paid under the policy without including such benefits in income for federal income tax purposes.

Tip: Although the proceeds from a life insurance policy will generally qualify for income tax exclusion only in the event of the insured's death, there may be exceptions to that requirement. In some cases, the tax exclusion may also apply to qualified accelerated death benefits made on behalf of an insured who is chronically or terminally ill. For more information, consult a tax advisor and/or other resources.

Caution: While life insurance death proceeds are generally exempt from federal income tax, they may not be exempt from federal estate tax and/or gift tax.

Transfer-For-Value--an Exception to the Rule

There is an important exception to Section 101 (a) (1) that you should be aware of: the transfer-for-value rule. If you transfer your interest in a life insurance policy to another party in exchange for valuable consideration, all or a portion of the death benefits the policy's beneficiary is eligible to receive may lose their tax-exempt status.

In the case of a transfer for value, when the insured party dies, the death benefits of the policy will be included in the beneficiary's income except to the extent of the amount the transferee (the new policyholder) paid for the policy plus any premiums subsequently paid by the new policyholder. Additional amounts in the form of death benefits received by the beneficiary will be subject to income tax. The transfer-for-value rule applies not only to an outright cash sale of a life insurance policy but possibly also to policy transfers involving forms of consideration other than cash.

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Is There an Exception to The Exception?

To the extent that the transfer-for-value rule is an exception to Section 101 (a)(1) of the Internal Revenue Code, there are also exceptions to the exception. The death benefits paid under a life insurance policy that has been transferred will not be subject to the transfer-for-value rule and will therefore retain tax-exempt status under any of the following conditions:

  • You transfer the policy to the person named as the insured party. The insured, of course, is the person whose death will trigger the payment of death benefits to the beneficiary.
  • You transfer the policy to a partner of the insured. Members of a limited liability company (LLC) taxed as a partnership are considered to be partners for this purpose.
  • You transfer the policy to a partnership in which the insured is a full partner.
  • You transfer the policy to a corporation in which the insured is a stockholder, an officer, or both.
  • You transfer the policy to a new owner so that the tax basis of the policy in the hands of the new owner is determined by reference to your tax basis in the policy. This might occur, for instance, in the case of a bona fide gift transfer of the policy or where the policy is transferred between spouses.

Caution: If you are the policyholder of a life insurance policy and are considering transferring the interest in the policy to another party, you should consult your tax advisor to determine if there is any way to minimize your overall tax liability and to determine if the transfer-for-value rule applies to your situation.

 

 

This material was prepared by Broadridge Investor Communication Solutions, Inc., and does not necessarily represent the views of The Retirement Group or FSC Financial Corp. This information should not be construed as investment advice. Neither the named Representatives nor Broker/Dealer gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information or call 800-900-5867.

 

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The Retirement Group is a Registered Investment Advisor not affiliated with FSC Securities and may be reached at www.theretirementgroup.com.



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