1. Frank purchased a $320,000 life insurance policy on his own life. A year late
ID: 2781692 • Letter: 1
Question
1. Frank purchased a $320,000 life insurance policy on his own life. A year later, when it had a value for gift purposes of $25,000, he assigned the policy to his son, Sam. A few months after making this gift, Frank died. Frank's wife had always been the named beneficiary and Sam failed to change the beneficiary designation.
a. At the time of Frank's death, who is the owner, the insured, and the beneficiary?
b. What is the adjusted taxable gift on this transfer? Are any gift taxes owed by Frank?
c. Assume Frank wanted Sam to benefit from this policy. Did Frank make a mistake in how this policy was transferred and if so, what was it?
d. Will the $320,000 death benefit value be included in Frank's gross estate?
Explanation / Answer
Solutions:
a.
Owner - The owner of the policy is Sam since Frank had transferred his policy to Sam before death (This normally happens through signing of a 'Transfer' letter)
Insured - Sam is the insured party since the life insurance was taken on his own life.
Beneficiary - Beneficiary continues to be Frank's wife since no change in beneficiary was made in policy documents
b.
Gift tax would be calculated on the 'Gift Value - Tax Exclusion limit'. For example, if tax exclusion limit is $14000, gift tax would be calculated on $25,000-$14000 = $11,000 only. In this example, adjustable taxable gift value is $11,000 (Please check local laws for exclusion limit)
Gift tax is paid by the person who makes the gift which in this case is Frank.
c)
Yes, Frank made a mistake by not changing the name of beneficiary. Ideally, he should have changed the beneficiary's name from his wife to Sam.
d) Normally, if the ownership is passed on, then the benefit value should not be included in the gross estate of the original owner (in this case, Frank).
However, as in the U.S and other jurisdictions, there is normally a 3-year rule (http://www.investopedia.com/terms/t/threeyearrule.asp) which enforces the value to be included in original owner's (Frank) estate if he dies within 3 years of making the transfer.
Therefore, since Frank died within 3 years of transferring the owenership, the death benefit value of $320,000 should be included in Frank's estate. (Please check local laws for the same)
GENERAL NOTE: Insurance is a highly regulated sector and the rules vary across countries and jurisdictions. I have already pointed the need to check local laws wherever necessary in answering the question. Therefore, please cross-check the local laws in your jurisdiction.
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