Owning Life Insurance Can Make Estate Planning Complicated

If you own an insurance policy on your life and want to keep the policy’s proceeds out of your taxable estate, one option is selling the policy to an irrevocable grantor trust.

This is preferable to gifting the policy because, if you transfer a policy to a family member or trust and then die within three years of the transfer, the policy’s proceeds will be pulled back into your estate.

But this three-year rule doesn’t apply if you transfer a policy as part of a “bona fide sale for adequate consideration.” The problem here is that, when life insurance is involved, it may trigger the transfer-for-value rule. A transferee who pays valuable consideration for a life insurance policy is subject to ordinary income taxes on the amount by which the proceeds received exceed the consideration and premiums the transferee paid.

An irrevocable grantor trust solves this problem because it’s structured so that you, the grantor, are the owner for income tax purposes but not for estate tax purposes. So the transfer-for-value rule won’t apply because, for income tax purposes, you’re essentially transferring the policy to yourself.

This strategy is complex, so please contact us before taking any action.

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Scott Husaby

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