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What Is It?

As the owner of a life insurance policy, you have a number of rights and privileges concerning the policy. These include the right to name and change your beneficiary designation, the right to choose and change settlement options, the right to withdraw from or borrow against the policy, and the right to receive dividends paid by the insurance company. One of your most important rights as a policyholder is the right to transfer ownership rights in your policy. This right gives your life insurance contract flexibility that it would not otherwise have and that other types of assets lack.

Most likely you are both the person named as the insured party in your life insurance policy and the sole owner of the policy. In some cases, however, the person named as the insured has none or only some of the ownership rights in the policy. This means, of course, that the insured is either a nonowner or only a part owner of the policy. Many policies are purchased and owned by someone other than the insured. Other exceptions to the general rule that insured and policyowner are one and the same may result from policy transfers.

A transfer simply involves reassigning, either through sale or gift, ownership interest in a life insurance policy to another individual, an institution, or an entity such as a trust. If you give or sell all the ownership rights in your policy to a new owner, you have completed a total transfer of policy ownership, also known as an absolute assignment. You can also give or sell some rather than all the ownership rights to another party, in which case you would remain a part owner of the policy. Just as there are times when it's appropriate to replace your existing policy, change your level of coverage, or simply leave the policy as is, there may also be circumstances that warrant a full or partial transfer of your policy.

Tip: This discussion assumes that the original owner in a policy transfer is the person whose life is insured by the policy and that ownership interest passes from this insured owner to a noninsured owner. Be aware, however, that many policy transfers involve transferring interest from a noninsured owner to another party. Such transfers may not involve the insured party at all (i.e., the insured may be neither transferor nor transferee).

Caution: Since the rules dealing with ownership rights vary from one policy to the next, you should carefully read the appropriate clauses in your policy if you are considering a transfer. The assignment clause, in particular, should give you most of the information you need. Many insurance companies reserve the right to refuse to guarantee the validity of any policy transfer or assignment.

Caution: If you transfer an interest in your policy to another party in exchange for valuable consideration, the death benefits payable under the policy will generally be included in the beneficiary's income when received by the beneficiary to the extent that such benefits exceed the amount the purchaser paid for the policy and any premiums paid by the purchaser. In addition, a transfer may involve other tax issues. You should consult a tax planning professional before you proceed.

When Might It Be Appropriate to Transfer Your Policy?

You Need Collateral for a Loan

This is the most common scenario for which transfers come into play. Say that you want to borrow money from a bank or other financial institution but don't have the traditional forms of collateral (e.g., real estate, investment assets) needed to back such a loan. You might think you're simply out of luck. However, if you own a life insurance policy, you may be able to use some or all of your ownership interest in the policy as collateral to secure the loan. The bank or company from which you want to borrow may, in fact, require that you do so as a condition of the loan.

This is known as a collateral assignment and involves transferring some or all of your policy ownership rights to the lending institution. It works as follows. If you (as owner and insured) pledge your policy as collateral for a loan and then die before the loan is paid off in full, your lender would generally be entitled to receive a portion of the policy's death benefits equal to the outstanding balance of your loan at the time of your death. The remainder of the death benefits, if any, would then be payable to the beneficiary or beneficiaries you designated in the policy.

Example(s): Say you own a life insurance policy that will trigger $100,000 in death benefits at your death. You borrow $50,000 from your local bank for home improvements and pledge your interest in the policy as collateral. If you die five years later having paid off only $25,000 of the loan, the bank will be entitled to collect the remaining $25,000 owed to them (plus any interest) from the life insurance death benefits paid by your insurance company. The remaining $75,000 in death benefits (adjusted for interest) would be payable to your beneficiary(ies).

Example(s): In another scenario, say you have the same life policy with $100,000 in death benefits but that you borrow $150,000 from your bank instead of $50,000. If you die having paid off only $25,000, the $100,000 in death benefits triggered by your policy would not be enough to pay off the $125,000 outstanding balance (plus any interest) of your bank loan. Thus, the bank would be able to collect the full amount of your life insurance death benefits, leaving your beneficiary(ies) with nothing. The bank would also be able to seize additional assets of sufficient value to cover the balance of the loan. However, if you die having paid off your loan in full, the bank would not be entitled to receive any of your death benefits, all of which would go to your beneficiary(ies).

As these examples show, the amount of death benefits that your lender can collect in the case of a collateral assignment depends on the balance of your loan at the time of your death. It is limited to the death benefit coverage amount specified in your policy.

Tip: If you need money, it may be more advantageous to borrow against the policy rather than pledging it as collateral for a bank loan. A policy loan may provide you with a more favorable interest rate than a bank loan. However, you should check your policy's loan provision section to make sure you are allowed to borrow against it. Also, since the amount you can borrow will generally be limited by the policy's cash value, make sure your cash value is sufficient to cover the amount of the loan you want. And remember, if you die before the loan has been paid off, the death benefit will be reduced by the amount of the loan still outstanding.

Caution: If you are planning on transferring policy ownership rights to a bank via a collateral assignment, check to see what type of assignment form your bank intends to use. The assignment form most used and most favorable to borrowers is the ABA assignment form. This form, developed by the American Bankers Association in cooperation with representatives of the life insurance industry, provides for the transfer of just enough policy ownership rights to protect your lender from financial loss. If your bank plans to use its own prepared assignment form, which may entitle them to receive more ownership rights than they need, request the ABA form with its more favorable borrowing terms.

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A Transfer Seems Advantageous for Income Tax Reasons

The cash value buildup in a life insurance policy is generally exempt from federal income tax if the policy terminates in a death claim. However, any cash value gain on the policy will be subject to income tax if you surrender the policy for cash. If you need to draw on the policy's cash value for whatever reason, a transfer might be a viable option that would allow you to avoid a heavy income tax burden and still get the money you need.

Let's say you want to surrender your policy so that you have money available to pay for your grandson's college education. If your grandson is in a lower income tax bracket than you, a sensible alternative might be to assign the policy to him so that he can make the necessary withdrawal himself. You could work out some other arrangement to reimburse your grandson for the resulting tax burden he would incur, but the bottom line would be a smaller total income tax bill on the same withdrawal that would otherwise have cost you more in taxes. Less money ends up coming out of your pocket to go to the federal government.

Caution: In the case of a straight assignment like the one described above, there may be federal gift and estate tax consequences that could potentially reduce or even exceed the income tax benefit of the transfer. If so, it may make more sense from a tax standpoint to borrow against the policy rather than surrender all or part of its cash value. For you to exercise this option, your policy must have a loan provision that allows you to borrow against it as well as sufficient cash value to cover the loan.

Tip: Another possible income tax consideration with life insurance concerns the issue of dividends, if any. In general, if you receive dividends on your policy that do not exceed your cost basis (i.e., the amount of your investment) in the policy, those dividends will not be included in your income. However, if the dividends received do exceed your cost basis, they may be subject to income tax. If so, it may be to your advantage for income tax purposes to structure an assignment of the policy to someone in a lower income tax bracket, rather than receiving the dividends yourself, and then making a gift of those dividends to the same person. However, as noted above, the assignment of the policy may have federal gift and estate tax implications.

A Transfer May Be Advantageous for Estate Tax Reasons

In general, if you own a life insurance policy and die with the policy still in your name, the death benefits paid under the policy will be exempt from federal income tax but not from federal gift and estate tax. The proceeds payable to your beneficiaries in such a case are includable in your estate and are therefore subject to the tax. Tax may not be incurred unless the total value of your estate (including the proceeds of insurance policies on your life that you owned upon your death) exceeds the applicable exclusion amount for the year of death. Because the proceeds may be subject to tax in your estate, this could ultimately mean less money for your beneficiary(ies). The reason that the proceeds are includable in your estate is simply that, as owner of the policy, you had an incident of ownership in it.

It follows that if you transfer ownership of the policy to someone or something else, you can minimize the tax that might otherwise apply to your life insurance death benefits. This is where a transfer or assignment of ownership rights might come into play. For example, one common strategy that policyowners use to protect life insurance death benefits from the bite of federal gift and estate tax is to create a trust and transfer ownership of the life insurance policy to that trust. If properly executed, this method can ensure that policy proceeds are paid to your beneficiary(ies) upon your death without being reduced by the tax.

Caution: Keep in mind that if you die within three years after transferring ownership of your life insurance policy, the death benefits payable under the policy may still be included in your estate for federal gift and estate tax purposes (according to Internal Revenue Code Section 2035). The IRS reasons that if you had any interest in the policy within the last three years before your death, any proceeds from it belong in your gross estate. While it's obviously impossible to know when you will die, you may want to take appropriate estate planning steps, including a well-timed policy transfer, based on your age, health, and other factors.

Tip: Life insurance death benefits payable solely to your surviving spouse may be eligible for what is known as the federal unlimited marital deduction. If this applies to you, you may not need to effect a policy transfer to avoid tax on policy proceeds. Bear in mind, however, that there may be no such unlimited marital deduction if death benefit payments can continue beyond your surviving spouse's death. When your surviving spouse dies, any remaining unpaid death benefits payable by reason of death would generally be includable in your surviving spouse's estate and become subject to gift and estate tax.

A Transfer May Be Advantageous for Tax Deductibility Reasons

This may be the case if you transfer your life insurance policy to a charity or to a charitable remainder trust . Aside from the good feeling you may derive from such a charitable act, this kind of transfer can provide you with considerable tax benefits. Specifically, if you relinquish all incidents of ownership (as defined by the IRS) in the policy, you may be eligible for one or more of the following: (1) a charitable income tax deduction, (2) a charitable gift tax deduction, and (3) a charitable estate tax deduction. However, if you retain any incidents of ownership or if you receive any economic benefit from the policy after the transfer, these deductions may not be applicable.

Tip: If you transfer your life insurance policy to a charity or a charitable remainder trust and then continue paying premiums toward the policy even though you no longer own it, those premium payments may also be tax deductible up to a certain amount.

Caution: Despite the obvious tax advantages of transferring your life insurance policy to a charity or a charitable remainder trust, Internal Revenue Code Section 2035 may apply and draw the death benefits payable under the policy back into your estate if you die within three years of the transfer. If the proceeds are includable in your estate through application of Section 2035, they may be subject to federal gift and estate tax. Keep in mind, however, that any applicable charitable deduction may offset or at least soften the tax consequences.

Caution: A transfer of your policy may bring into play additional tax issues. For example, the transfer of a policy to an employee as compensation for services performed may have its own special tax considerations. For more information on this and other tax issues, you should definitely consult additional resources.

You Simply Need the Money

This applies specifically to policy transfers by sale. If you desperately need money and need it quickly, a sale of your life insurance policy to another party for cash or other consideration may be an appropriate option.

Caution: Keep in mind that the transfer-for-value rule may apply to the sale of your policy for cash or other forms of valuable consideration. If so, all or a portion of the death benefits payable under the policy may lose their status as income tax exempt. With this in mind, you may want to consider a transfer by sale only if you have no other means of raising the money you need.



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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