Thus+ Counselor s Corner When Your Clients Lives Change, Be Sure Their Life Insurance Beneficiary Designations Keep Up Situation: One of the most important decisions the owner of a life insurance policy makes is deciding who to name as the beneficiary. On the surface a beneficiary designation may seem simple and straightforward, but they have the potential to be complex. Unfortunately, many people do not put much thought into the identification of a beneficiary when setting up their life insurance policies even though some of the most common errors are made with respect to the naming of beneficiaries. While this error can cause unnecessary taxes, the most serious result of this mistake is that the death benefit proceeds may pass to unintended individuals. Beneficiary designations should be considered carefully and reviewed regularly. Consequently, when performing a policy review, in addition to reviewing the performance and market competitiveness of the policy you should also review errors in beneficiary designations. This Counselor s Corner includes a discussion of three situations that may arise in life insurance policy designations that create tax problems. In addition, we have attached a checklist to help you in your review of beneficiary designations as well as a guide on drafting life insurance beneficiary designations. Solution: There are several tax considerations that can arise when establishing or changing a beneficiary designation. Following are three of the most commonly occurring situations and suggestions for correction: Making a Taxable Gift by Having Three Different Parties on a Policy: The Goodman Rule. The most common error I see is where the policy owner unknowingly makes a large taxable gift of the death benefit because of poor beneficiary planning. This can occur when the policy owner, insured, and a named beneficiary are all different people or entities. For example, this unintended tax can occur when a parent is an insured, the spouse is owner, and children are beneficiaries. In this situation, at the death of the parent the spouse/policy owner will be deemed to have made a taxable gift to the children. This result can be avoided by making sure the policy owner is either the insured or the beneficiary. The same type of error can occur in the business situation, but with a different tax result. Periodically, I see a policy structured where the business is the policy owner, the insured is an employee/business owner and the spouse/family as beneficiary(s). In this situation, at the death of the insured the death proceeds received by the spouse/family are likely to be considered income taxable compensation or business distribution. Having a Policy Death Benefit Become Taxable Income by Violating the Transfer-for-Value Rule. When an insured dies, policy death proceeds are generally received by the beneficiaries income tax-free under IRC 101. However, this income tax exclusion can be lost if prior to the insured s death the policy owner transferred an interest in the policy to someone else and received valuable consideration in exchange. Many financial advisors are aware that the sale of a policy and change of ownership pursuant to a life settlement causes the proceeds to be subject to income tax. Likewise, many advisors are aware that a change of policy ownership from a corporation to a co-shareholder pursuant to the funding of a cross-purchase buy-sell agreement also triggers the rules application. Unfortunately, many advisors are not aware that a change in beneficiary designations can also cause
the proceeds to be subject to income tax. Fortunately, there are several exceptions to the rule. For example, a transfer to: the insured, or a partner of the insured; a partnership where the insured is a partner; a corporation where the insured is an officer or shareholder transfer where the cost basis of the policy carries over from the transferor to the transferee Because the consequences for violating this rule do not apply until the insured s death, it may be possible to cure the violation while the insured is alive by retransferring the policy to one of the recognized exceptions. Causing the Death Benefit to Become Taxable by Violating the Employer Owned Life Insurance (Section 101(j)) Rule. For policies issued after August 17, 2006, where the business is owner and beneficiary and the insured an employee at the time of policy issue, the death benefit is taxed as ordinary income to the extent the amounts paid under the contract exceed premiums and other amounts paid by the employer. However, death proceed is not taxed under this provision where the following two conditions are met: employer satisfies certain notice and consent requirements prior to policy issue and certain safe harbor exceptions apply. Unfortunately, the notice and consent disclosure requirements are often missed at policy issue because they are not an insurance company requirement and many companies do not provide forms as part of the application process. Like the transfer-for-value rule, since this rule does not apply until the insured s death, it may be possible to cure the oversight while the insured is alive by executing a notice and consent prior to issue of a new policy. Of course, this means the insured must be able qualify for new insurance coverage. Of all the errors that occur with life insurance beneficiary designations, the one that occurs with the greatest frequency is the failure to regularly review beneficiary designations. Unfortunately, after the purchase of a policy many people put the whole thing out of mind. The policy is locked-up, along with other important papers, and not looked at again until the time to file a death claim. To the great surprise of many, an ex-spouse or deceased individual may be the beneficiary. The solution to this problem is easy.... make sure you regularly help your clients review their beneficiary designations. Changing a beneficiary designation is very simple, but before you proceed with the change you need to make sure you will not create an unintended tax problem in the process. This material has been prepared to assist our licensed financial professionals and clients advisors. It is designed to provide general information in regard to the subject matter covered. It should be used with the understanding that we are not rendering legal, accounting or tax advice. Such services must be provided by the client s own advisors. Accordingly, any information in this document cannot be used by any taxpayer for purposes of avoiding penalties under the Internal Revenue Code. Insurance policies contain exclusions, limitations, reductions of benefits and terms for keeping them in force. Policies and or features may not be available in all states. Securities and Insurance Products: Not Insured by FDIC or Any Federal Government Agency. May Lose Value. Not a Deposit of or Guaranteed by Any Bank or Bank Affiliate. 2017 Diversified Brokerage Services, Inc. 5501 Excelsior Blvd., Minneapolis, MN 55416-5153 www.dbs-lifemark.com 2
Life Insurance Diversified Brokerage Services, Inc. Beneficiary Designation Checklist The below questions are designed to help the financial advisor identify some of the frequently encountered areas where beneficiary designations can create problems. This checklist of questions and supporting discussion points can be used when establishing beneficiary designations in the original application as well as when reviewing an existing policy designation. Are the Beneficiary Designations Clear? Is each primary beneficiary clearly identified? If the policy owner wants the death benefit to be divided other than equally has the beneficiary s percentage interest been included and do all the beneficial interests add up to 100%? If there are multiple individual beneficiaries and one or more of the beneficiaries dies before the insured does the policy owner want the remaining surviving beneficiaries to divide the proceeds equally? (beneficial interest is joint with right of survivorship) If no, has language been used to distribute death proceeds as tenants-incommon? Are contingent beneficiary(ies) clearly identified? Are Any of the Beneficiaries Minors? If yes, is the beneficiary designation structured as a minor trust or custodian under UTMA (Uniform Transfer to Minors Account)? If no, death benefits will not be paid directly to minors. Instead, payment is made to someone appointed by the court to be the minor s guardian/ custodian. Does the Policy Owner Live in a Community Property State? If yes, is the spouse the beneficiary of more than 50% of the policy death benefit? If no, has the spouse given written consent or is the premium paid with policy owner s separate property funds? If no, the spouse will be considered to have made a gift to the nonspouse beneficiary(ies). Are Different People/Entities Named as Insured, Policy Owner (s) and Beneficiary(ies)? If yes, where the policy owner is an individual at the insured s death s/he will be considered to have made a gift to the beneficiary(ies). If yes, where the policy owner is a business entity at the insured s death there is a risk that the death proceeds may be taxable as income. Is a Business a Beneficiary and Policy Owner? If yes, is the insured an appropriate insured under Internal Revenue Section
Business insurance Beneficiary Designation Checklist 101(j)? (An employee at any time during the 12-month period before the insured s death, or a director, a highly compensated employee, or a highly compensated individual at the time the contract was issued.) If yes, has the notice and consent requirements been met before policy was issued? If no, the death proceed in excess of cumulative premium payment will be subject to income tax. After the Initial Purchase of the Policy Did the Policy Owner Receive Anything of Value in Exchange for Changing the Beneficiary or Owner? If yes, was the transfer to an exempt transferee under Internal Revenue Code Section 101(a)(2)(A) and (B)? (Transfer to the insured, a partner of the insured, a partnership in which the insured is a partner, a corporation in which the insured is an officer or shareholder, or a transfer where the transferee s basis in the policy is determined in whole or part by reference to the basis of the transferor) If no, the death benefit will be subject to income tax at the insured s death unless the policy is retransferred to an except transferee. On an Existing Policy Does the Beneficiary Designation Still Accomplish the Owner s Objectives? Has the beneficiary designation been reviewed recently? Is the reason for having the life insurance the same as when you purchased the policy? Has the number of desired beneficiaries remained the same? (Example: Number of children increased since purchasing the policy) Is your marital status the same as when you purchased your policy? Are your beneficiaries abilities to manage their financial affairs the same as when you purchase your policy? Has the passage of time or the occurrence of events not anticipated when the policy was purchased caused the beneficiary designation to be outdated? This material is designed to provide general information in regard to the subject matter covered. It should be used with the understanding that we are not rendering legal, accounting or tax advice. Such services should be provided by your own advisors. Accordingly, any information in this document cannot be used by any taxpayer for purposes of avoiding penalties under the Internal Revenue Code. Life insurance policies contain exclusions, limitations, reduction of benefits and terms for keeping them in force. Your licensed financial professional will provide you with costs and complete details. Securities and Insurance Products: Not Insured by FDIC or Any Federal Government Agency. May Lose Value. Not a Deposit of or Guaranteed by Any Bank or Bank Affiliate. 2017 Diversified Brokerage Services, Inc. 5501 Excelsior Blvd., Minneapolis, MN 55416-5153 www.dbs-lifemark.com
Beneficiary Designation Guidelines One of the most important decisions the owner of a life insurance policy makes is deciding who to name as the beneficiary. Beneficiary designations should be considered carefully and reviewed regularly. We have developed this guideline to help you save time and avoid delays. The examples below are suggestions only; each carrier will have their own particular guidelines. Please note that carriers are asking more detailed information about the beneficiary such as address and social security number in an attempt to better identify and track beneficiaries. We understand that some clients may object to such inquiry; but recent litigation against some life insurance carriers for not paying death benefit when a claim is not filed because the beneficiary is not aware there is a policy has caused carriers to ask for more information to be in a better position to find beneficiary(ies) of a known deceased insured. Beneficiary(ies) Language/ Guidelines Comments Estate of the Insured Spouse of Insured Minor Child/ Beneficiary Multiple Adult Children/ Beneficiaries (If a beneficiary dies before the insured proceeds pass equally to the surviving beneficiaries) Estate of (full name) Insured. Only use in very rare situation because the designation will cause the proceeds to be subject to creditors. Where it s used we strongly suggested that the financial advisor document their case file that they advised the insured against/drawbacks to the designation. (Full name of spouse) spouse of the insured. Social security number See Testamentary Trust where proceeds are paid to trust for the minor s benefit. Uniform Transfers to Minors Act (UTMA): (Full name of custodian) as Custodian for (full name of child) son/daughter, under the (State) Uniform Transfers to Minors Act. Provide the following information: Full name of each beneficiary Relationship to the insured Date(s) of birth for each child Social security number for each child Current addresses of each child If the beneficiary is a minor at the insured s death, the death benefits will not be paid direct to the minor. Instead, payment is made to someone appointed by the court to be the minor s guardian/custodian. Instead of the expense and complexity of a court appointed custodian, a trustee of a trust for the minor s benefit, or a custodian under the state s UTMA can be used. The insured should normally be the policy owner where there are multiple beneficiaries. Having three different designations on a policy can cause adverse gift tax (e.g., having a parent as the insured, one child as owner, and multiple children as beneficiaries). While it s possible to have the same owners and beneficiaries, where there are multiple owners any policy action will require the consent of all owners. Where there are multiple beneficiaries proceeds are distributed to the surviving named beneficiaries in equal shares (joint with right of survivorship) except where tenants in common is requested.
Multiple Beneficiaries (tenants in common) Trust Under Will (Testamentary Trust) Living Trust Provide the following information: Full name of each beneficiary Percentage (must add up to 100%) Relationship to the insured Date(s) of birth for each beneficiary Social security of each beneficiary Current addresses of each beneficiary (Full name of trustee) as trustee of (full name of the trust if applicable) created in the instrument admitted as my Last Will and Testament provided, should my Last Will and Testament not contain (name of the trust) or should I die intestate, then equally to my then living children (name of children). (Full name of trustee) as trustee of (full name of the trust) dated (date of trust). An example where the desire is to have the death benefit pass to heirs of a beneficiary that predeceases the insured (tenants in common) instead of the surviving beneficiaries: 50% to (name of beneficiary #1), if living, otherwise to the estate of (beneficiary #1); and 50% to (name of beneficiary #2), if living, otherwise to the estate of (beneficiary#2). Avoid using terms per capita, per stirpes, and by representation Avoid using the terms issue, heirs and descendants. This beneficiary designation is often used for trusts established to benefit minor children. Such a trust may not exist at the insured s death so it s important to address this contingency with a successor beneficiary. If the trust is established to keep the policy proceeds out of the estate of the insured(s) the trust should also be the owner. Corporation Partnership Limited Liability Company Charitable Organization Contingent Beneficiary Collateral Assignment (Full name of company) Inc., a (state) corporation. (Full name of company) a (state) partnership. (Full name of company) LLC, a (state) limited liability company. (Full name of charity) a (state) corporation. Way for lender to receive some policy death proceeds while NOT being a beneficiary. It s important to designate contingent beneficiary(ies) especially when the primary beneficiary(ies) are individuals. A separate form where policy owner transfers all or a portion of rights to death proceeds to an assignee/lender with policy beneficiary the balance. This is designed to provide general information in regard to the subject matter covered. It should be used with the understanding that we are not rendering legal, accounting or tax advice. Such services should be provided by your own advisors. Accordingly, any information in this document cannot be used by any taxpayer for purposes of avoiding penalties under the Internal Revenue Code. 2017 Diversified Brokerage Services, Inc. 5501 Excelsior Blvd., Minneapolis, MN 55416-5153 www.dbs-lifemark.com For the Education of Financial Representatives. Not for use with the General Public.