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Life Insurance
In General
Changing policy ownership
Determining
Incidents of Ownership
Changing Beneficiary Designation
Group Insurance Policies
Funding Disability Insurance
Additional Documents Required
Special Funding Considerations:
Loans Against a
Policy
Funding
Insurance Policies of Divorced
Clients
with Minor Children
Ascertain
Whether A Policy is Collateral for a Loan
IMPORTANT NOTICE TO USERS:
The information contained in this legal bulletin is general in nature and
does
not constitute legal advice. Non-attorneys should consult
with a qualified estate planning attorney regarding any trust funding matter.
Issues of state law may contradict any information contained herein.
Accordingly, the information contained in this legal bulletin and on our web
site should not be relied upon without first confirming with a qualified
attorney that the legal requirements in a particular state are satisfied.
This web site, our products and services, and any accompanying resources
are
not intended to be a substitute for research, continuing legal education, or a
thorough knowledge of the law. In using any aspect of this
web site, the user, whether attorney or non-attorney, agrees to assume all
responsibility for the validity of the information contained herein.
In General: Funding Life Insurance can involve the transfer of ownership of a policy, the change of
beneficiary designation of a policy, or both. As a general rule, ownership of a policy is
usually changed when the policy has a cash value. By transferring ownership of the policy
into the trust, a successor disability trustee could access the cash value or other rights
under the policy in the event the trustmaker was incapacitated.
If there is no cash value in the policy, it may still be a good idea to
transfer the ownership of the term policy to the trust. Many term policies allow the
policy to be converted to a whole life policy without the need to verify insurability.
In
the event of the trustmakers' incapacity, if the term policy is owned by the trust, the
trustees could exercise the right to convert the policy to a whole life policy.
Ownership of a
policy is changed by:
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Completing the company's institutional change of ownership form*;
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Attaching a change of ownership instruction letter signed by the
policy owner;
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If the change of ownership form requires a witness or notary, make
certain that the appropriate formalities are followed.
*To
obtain a insurance company's institutional change of ownership form, contact the
life insurance company or seek the assistance of an estate planning attorney
with experience in trust funding.
Regardless of whether there is cash value, the beneficiary designation
is generally changed to name the policy owner's trust as the primary beneficiary.
This
will allow the insurance proceeds to receive the benefits of estate tax planning, creditor
protection, bloodline protection, and values promotion contained in the trust.
If you have any questions whether or not you should be changing the ownership of
your life insurance policies, we recommend that you consult with your estate
planning attorney to determine what strategies are best for your family and
estate.
Determining Incidents of
Ownership:
While life insurance proceeds pass income tax free, proceeds of life
insurance policies are included in a person's estate when calculating estate tax
liabilities. The IRS uses a standard called Incidents of Ownership
to determine whose estate the life insurance proceeds should be included. A person who has incidents of ownership of an insurance policy
will have the value of that policy taxed in their estate. The technical
term "Incidents of Ownership" is defined in IRS Regulation
20.2042-1(c)(2).
Although this is not intended to be an exhaustive list, incidents of
ownership will be established if the insured has any of the following powers:
1. To change the beneficiary or ownership of the policy;
2. To surrender or cancel the policy;
3. To assign or revoke an assignment of the policy;
4. To pledge the policy as collateral for a loan;
5. To borrow against the cash surrender value of the policy;
6. To change the settlement options of the policy;
7. To be the trustee of a trust which owns the insurance on their life.
If any of the foregoing powers apply to the insured, then the insured has incidents of ownership.
CAUTION: You should consult with your estate
planning attorney to determine whether any other circumstances exist that could
trigger incidents of ownership.
Beneficiary Designation
is changed by:
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Completing the company's institutional change of beneficiary designation form*;
-
Attaching a change of beneficiary designation letter signed by the
policy owner;
-
If the change of beneficiary designation form requires a witness or
notary, make certain that the appropriate formalities are followed.
*To
obtain a insurance company's institutional change of beneficiary form, contact
the life insurance company or seek the assistance of an estate planning attorney
with experience in trust funding.
Group Insurance Policies:
Many employers provide group life insurance as an employee benefit.
If your employer provides such benefits, contact the company human resources department
for the appropriate forms necessary to change the beneficiary. Generally, the ownership of
a group policy cannot be changed, although most group policies will allow the beneficiary
designation to be changed to name the trust. Again, the company human resource department
can provide you with the available options under your group policy.
Funding Disability
Insurance: As a general rule, most disability insurance policies do not allow
a trust to be named as the beneficiary. This is certainly an odd policy, as it would
require the payment of proceeds to be subject to the probate court if the insured is
completely incapacitated. It will be necessary to contact the insurance company to determine whether
the policy can be funded. NOTE: If the
insurance company will not allow the policy to name the trust as
the beneficiary, you should consider obtaining a Durable Special Power of Attorney to
control the payment of proceeds in the event the insured is completely incapacitated.
We recommend that you seek help from you estate planning attorney for any disability insurance
policies.
CAUTION: If a
power of attorney is utilized, you should have your estate planning attorney
send a copy of the power of attorney to
the insurance company asking them to agree in writing that they will honor the power of
attorney. Often, powers of attorney are never submitted to an insurance company until after
the maker is incapacitated. Once incapacitated, there is little that can be done short of
initiating a probate proceeding.
Additional Documents
Required: Many insurance companies may request verification that the trust is
actually in existence. Your estate
planning attorney can assist you with the documentation
that is required to satisfy the requirements of each institution. Generally,
including a copy of an Affidavit of Trust or the pages of the trust reflecting the trust
name, current trustees, and the signatures can satisfy this requirement. It is very rare
for an insurance company to require the original policy to be returned. However, should
this request be made, it will be necessary to include the original policy.
We recommend that you seek the assistance of your estate planning attorney
in determining what trust documentation is required by various insurance
companies.
Special Funding
Considerations:
Loans Against a Policy: Many
policies that have a cash value allow the insured to borrow against the cash value.
If a
loan has been taken against the policy, the company may not allow the ownership of the
policy to be changed to a revocable living trust until the loan is re-paid.
Although this
restriction may effectively prevent the funding of the policy ownership, most companies
will allow for the change of beneficiary designation. If you are able to repay the
loan, you may want to consider repaying it so that the ownership can be re-titled to the trust.
If
repayment is not an option, then both changing the ownership and beneficiary
designation may not be possible
until a later date.
Funding
Insurance Policies of Divorced Clients with Minor Children: If
you are divorced with minor children from the former relationship, it will be important to
ascertain whether the divorce decree requires you to maintain a life insurance
policy on your life for the benefit of a minor child. This is a common provision in many
divorce decrees and is intended to assure that adequate financial resources would be
available to support or educate a minor child to emancipation. If the divorce decree
imposes such a life insurance requirement, changing the beneficiary designation may result
in the client violating their divorce decree. State law will control what options are
available. NOTE: Prior to taking any funding action, you should consult with an attorney
licensed in the state where the divorce decree was executed to ascertain what funding
options would not result in violating the divorce decree. Funding options
that your estate attorney may recommend include:
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Taking no action in relation to the beneficiary designation until
the minor child is emancipated;
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Creating a special "sub trust" within the
revocable living trust for the sole benefit of the minor child; this sub
trust would generate a specific distribution of the insurance proceeds to
the new "sub trust";
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Seeking written consent from the former spouse to
fund the trust.
CAUTION: If you
are divorced and have minor children from the former relationship, we strongly
recommend that you seek counsel from your estate planning attorney when funding your trust.
Ascertain
Whether A Policy is Collateral for a Loan: From time to time, clients have
borrowed money from financial institutions. The loan may take many forms including an
educational loan or line of credit. Frequently, financial institutions
require a
borrower to assign their life insurance proceeds to the financial institution as
collateral for the loan. Transferring the ownership or changing the beneficiary
designation may result in acceleration of the loan repayment.
Have your estate planning attorney contact the lender directly to ascertain what actions they will take if
the policy is funded. Lenders may allow the loan to be assigned to the trust while other
lenders may require the old loan to be replaced with a new loan naming the living trust as
the borrower. What action the lender takes will often depend on whether there has been a
change in interest rates. Regardless of what option the lender accepts, they will most
likely insist on reviewing an entire copy of the trust agreement to ascertain whether
there are any restrictions in the trust document which prevent encumbering the trust
property.
Be advised that there may be additional expenses charged by the lender
for reviewing the trust document or preparing/reviewing an assignment to the trust.
You should be prepared to assume any additional expenses related to the lender
reviewing the trust document.
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