It seems like a strange question to ask, but it could be important to avoid paying unnecessary taxes or having the money squandered. You’re not required to own the life insurance policy that covers your life, and it may not be a good idea for you to own it. Why does it matter? Because depending on who owns the policy and who the beneficiary is, the insurance proceeds could end up in your estate (possibly incurring estate taxes) or the proceeds could be considered a gift (incurring gift taxes). Here are a few situations to consider:
If You’re Married…
If your spouse is the beneficiary of your life insurance policy (and they’re still alive when you die), it’s not going to matter if you or your spouse owns the insurance policy. If you own the policy on your life and your spouse is the beneficiary, then the insurance proceeds will be considered part of your estate for tax purposes. However, you get an unlimited marital deduction, which means that you don’t have to pay estate taxes on anything that goes to your spouse. So in this case, it doesn’t really matter (as long as it’s owned by you or your spouse).
If your spouse’s estate could end up over the estate tax exemption (currently, $3.5 million in 2009) because of the insurance proceeds plus other assets, you may want to consider an irrevocable trust to hold the insurance policy and the proceeds. But if that’s your situation, you should be talking to an attorney or financial planner and not getting free information on the Internet. Your situation is too complex for a do-it-yourself solution.
For most of us (who don’t have assets plus insurance over $3.5 million) this will never be a problem. It doesn’t really matter if you or your spouse own the policy if your spouse is the beneficiary.
If You’re Single or Widowed…
If you’re single, it’s generally best for the beneficiary of the policy to be the owner. If you own the policy on your life, then the proceeds will be included in your estate as a taxable asset. Now, if your estate won’t exceed the estate tax exemption (again, $3.5 million in 2009), this doesn’t really matter at all. You won’t owe any estate taxes anyway.
This logic wouldn’t apply if the beneficiary is a minor because it’s more important to make sure the money will be handled properly. In that case, you’ll want to make the designated guardian the beneficiary and owner of the policy or use an irrevocable trust to own and be the beneficiary of the policy. The trust would then contain provisions for how the proceeds should be distributed to the minor or the minor’s guardian. If that’s your situation, you’ll need to meet with an estate attorney to get advice about your circumstances.
Finally, you don’t want to have a situation where the owner, insured person, and beneficiary are all different people because of gift tax consequences. For example, if your dad owns the life insurance policy that covers you but your child is the beneficiary, when you die the IRS will consider the insurance proceeds a gift from your dad to your best friend. Your dad would then owe gift taxes on the insurance proceeds. This is not a good thing and these unnecessary taxes can be easily avoided. The solution in this case is to have the child be the owner and the beneficiary. If that child is a minor, read the above paragraph for advice.
If you have questions about your specific situation, feel free to leave them in the comments and I’ll try to help. But if you have complex circumstances, you should probably meet with an estate attorney to get the help you need. Yes, it will cost money, but it’ll cost much less than a mistake would.