Q&A Understanding the Transfer-for-Value Rule

Transfer of Value Rule Concept Depicts hands of two people discussing contract.

Presented by Kris Maksimovich, AIF®, CRPC®, CPFA®, CRC®:

In general, life insurance death benefits are exempt from taxation. If, however, you transfer a life insurance policy to another party in exchange for money or any other kind of material consideration, the death benefit proceeds may become fully or partially taxable. This is known as the transfer-for-value rule.

What are the tax consequences of transferring ownership of a life insurance policy?

Under the transfer-for-value rule, changing the ownership of a life insurance policy for money or other material consideration can have two potential income tax results:

The existing owner realizes tax on the policy’s gain in the year of the transfer.
At the death of the insured, the beneficiary incurs income taxes on the death benefit in excess of the new owner’s basis. (The basis is what the new owner paid for the policy and any subsequent premium payments.)

Are there any exceptions?

Exceptions to the transfer-for-value rule include policy transfers:

To the insured (or the insured’s grantor trust)
To a corporation of which the insured is an officer or a shareholder
To a partnership in which the insured is a partner
To a partner of the insured
Between corporations in a tax-free reorganization, if certain conditions exist
That represent a bona fide gift

When does the transfer-for-value rule commonly apply?

The transfer-for-value rule is often triggered when a business or business owner transfers an insurance policy (or any interest in a policy) to another co-owner in return for money or “money’s worth”—that is, any valuable consideration or service. It can be a reciprocal promise between business co-owners to name each other as beneficiaries or to use the proceeds to purchase their business interests at death. Although gifts don’t fall under the transfer-for-value rule, it’s hard to argue that a transfer between business parties is a bona fide gift.

If you’re unsure whether transferring a life insurance policy will trigger the transfer-for-value rule, be sure to seek the advice of your insurance agent or tax advisor.

This material has been provided for general informational purposes only and does not constitute either tax or legal advice. Although we go to great lengths to make sure our information is accurate and useful, we recommend you consult a tax preparer, professional tax advisor, or lawyer.

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Kris Maksimovich is a financial advisor located at Global Wealth Advisors 4400 State Hwy 121, Ste. 200, Lewisville, TX 75056. He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network^®, Member FINRA/SIPC, a Registered Investment Adviser. Financial planning services offered through Global Wealth Advisors are separate and unrelated to Commonwealth. He can be reached at (972) 930-1238 or at info@gwadvisors.net.