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Who owns a life insurance policy when someone dies?

Life insurance is the very best way to provide an “instant estate” for your family if you die unexpectedly. Term policies are relatively inexpensive, and can provide much-needed cash for your survivors. Life insurance can also be a good investment to provide funds for college or other expenses. Whole life policies, while more expensive than term policies, usually have generous borrowing options and build in value throughout the life of the policy. This value can be used to finance education, pay off high-interest debt, or provide a “nest egg” for future expenses. Clearly, life insurance can be a wise investment which can insure your family’s financial security.

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However, while life insurance is often a sensible purchase, many people do not understand the ramifications of insurance policies and are confused about the best strategies to benefit their loved ones. It is very important to understand who owns your policy, what your responsibilities are regarding the policy, and who will benefit from the policy. Failure to understand these issues can result in an expensive setback in your plans to benefit your loved ones, costing them thousands of dollars in unnecessary taxes and severely reducing their intended revenue.

In order to understand the ownership issue of life insurance, it is important to realize that there are three parties involved in any insurance policy. The insured is the person whose life is of concern to the policyholder—when this person dies, the benefit will be paid. The policyholder, who may or may not be the insured, is also called the owner of the policy. This person bears the responsibilities of maintaining the policy and choosing its parameters, including the amount designated for each recipient. Finally, the beneficiary is the person to whom the money will be paid upon the death of the insured.

Often, beneficiaries are spouses, children, grandchildren, or other loved ones, although some policy beneficiaries are business entities rather than individuals. It is possible to have multiple beneficiaries to a life insurance policy, and for the benefits to be paid in varying amounts to each person. Many people choose to leave one-half of the benefits to a spouse and divide the rest among their children, although there are many ways of dividing benefits.

Confusion sometimes arises when the insured and the owner are not the same person. For example, a company may purchase insurance on its partners in order to provide immediate cash in case of a sudden death. In that case, the corporation might be the owner of the policy, rather than an individual. Sometimes a spouse or parent is the owner of a policy for a family member.

The owner of the policy has several important responsibilities. Primarily, the owner must maintain the premium payments on the policy. The owner must also choose the beneficiaries and other options on the policy, and has the power to borrow on the policy if this is allowed. The owner enjoys all the rights of the policy until the death of the insured, at which time the policy is “paid out” or liquidated.

While the issue of ownership is sometimes confusing, the real problem with ownership of a policy usually arises when the insured and owner are the same person, and estate tax is assessed on benefits. If a person dies and owns a life insurance policy on his own life, the beneficiaries will be paid according to the terms of the policy. However, in this case, the money paid will be considered part of the owner’s estate, driving up the total value. Estate tax, which can be exorbitant, will be assessed on any amount over one million dollars, barring any changes in estate tax law. If the policy is for more than this amount, this could mean substantial tax consequences for the estate of the deceased—sometimes up to half the value of the policy.

For this reason, many financial advisors will suggest that ownership of large insurance policies be transferred to a beneficiary at least three years prior to death, which will avoid the estate taxes. However, before transferring any life insurance policy’s ownership, it is important to consult with an expert to ensure that you understand all the consequences of this action. Divorce and other changes in financial outlook can affect the feasibility of this strategy.

While life insurance remains the best and cheapest way to benefit your family in the case of your unexpected death, it is important to consider the consequences of ownership. Talk to a financial advisor to determine the best way to set up your life insurance policies and avoid unnecessary taxes or other costs to your loved ones.

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