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You are here: Experts > Money > Personal Insurance > Life & Health Insurance > Transfer of policy ownership
Expert: Willard R. Brumbaugh, LUTCF, CSFP - 11/8/2009
Question
QUESTION: Good morning. Back in 1986 my parents bought my husband and I each a $10,000 single premium whole life policy as a gift. I am the owner of my husband's policy and he is the owner of mine.The current cash value of each policy is approx $29,000 with death benefit on his policy for $56,000 and on my policy for $65,000 (so the current cash surrender value is approx 50% of the death benefit). When I checked with the insurance company a few months ago they told me that we would responsible to pay taxes on approx $20,000 (for each policy) if my husband and I were to cash them out. We would like to transfer ownership of these policies to our 2 sons so that they could be the ones to cash out the policies and use the money for further education. Both sons (age 23 and 25) are at a much lower income tax rate than my husband and I). My questions are:
1.Is this possible?
2. I assume it would be best to have each son become 50% owner of each policy so that most of the cash value would be considered a gift. Am I wrong?
3. With the goal of cashing out these policies would it be better to do it ourselves or transfer ownership to our sons and let them cash them out?
You help is appreciated,
Monica P.
ANSWER: Dear Monica,
It is possible, but there are issues.
Each of you can give up to $13,000 of value this year to as many people you want without being subject to a gift tax being charged to you. In your question you are proposing to gift approximately $58,000 to your sons. Consequently, you and your husband would be obligated to pay about $3,000 in gift taxes.
These policies, if they had been issued on or after June 21, 1988, would have been Modified Endowment Contracts. Liquidating or borrowing from such policies prior to age 59 1/2 would have resulted in the 10% premature distribution penalties applied to annuities and IRAs. Since these are not MECs, funds may be borrowed without taxes being charged and without the penalties.
It is my understanding that if your sons were to cash out these policies, they would be paying income taxes on the entire gain, in addition to what you and your husband paid in gift taxes.
The current Internal Rate of Return on the surrender value of these policies is about 4.75% tax-deferred. The IRR on the Death Benefits at this time would be 8.14% income-tax-free. My suggestion would be that you keep the policies and lend them funds borrowed from the policies. This would be the cleanest path to helping them, while maintaining the mathematical advantages afforded by these policies.
Willard R. Brumbaugh, LUTCF
www.willardbrumbaugh.com
(888) 792-2379
---------- FOLLOW-UP ----------
QUESTION: I didn't think about the gift tax aspect, which is significant.
Would another option be for me to remain owner of my husband's policy yet add each of our sons a 1/3rd owner this year )which would reduce the gift amount keeping it under 13,000#. And then next year transferring my remaining 1/3rd policy ownership to them? Then they each end up 50% policy owner, and when #and if) they cash out the policy they would be paying ordinary income tax on the approx 20,000 in earnings that have accured since the policy was taken out. For 2009 they are both in the 10% tax rate. For 2010 they will be at 25%. By 2010 they will both be young military officers so I'd like for them to have access to the cash value. I do see that these policies have actually performed decently, thanks for the calculations.
Monica
ANSWER: Dear Monica,
I would like to know more about these policies. What company or companies are these policies with? Are they Participating Whole Life? Has the Face Amount grown since they were purchased? What is the current internal interest that is being paid? What is the loan interest - both current and guaranteed?
Willard R. Brumbaugh, LUTCF
---------- FOLLOW-UP ----------
QUESTION: The policies are both with Merrill Lynch. I don't know whether they are Participating Whole Life, the basic policy identifies them as Single Premium Whole Life. The guaranteed death benefit on the policy where I am the insured has not grown,on the policy where my husband is the insured has grown from 43,000 to 56,000. As of 11/12/08 the unloaned cash value interest rate until 11/09 was 4%, and the current loaned cash value interest rate was 6%. The policy of which I am the insured (death benefit of $65,000)has a guaranteed cash value by year 39 (in about 15 more years) of $34,500 and the other policy has already passed its year 39 minimum guaranteed cash value of $29,000. At this time there is no surrender fee. My husband and I have an adequate amount of other life insurance and really don't need the coverage from these policies. We do not need to take out a loan. When my parents originally bought us these policies they were for the purpose of helping pay for our son's college, but the money wasn't needed.
Thanks so much for taking the time to review all of this!
Monica
Answer
Monica,
Income tax on $40,000 at 10% plus 50% gift tax on $6,000 would be $7,000. 25% income tax on $40,000 would be $10,000. And 30% tax on the $40,000, if you were to cash in the policies, would be $12,000. If you are not concerned about the $3,000 coming out of your pockets, if your sons need the money this year, gifting the policies to your sons would be the least expensive way to go.
On the other hand, you could gift one policy each year, thus eliminating the gift tax. The second year, when they are in the 25% bracket, their tax would be increased by $3,000 - the difference between 25% and 10% on $20,000. This way they end up paying the $3,000, instead of you. There would be a slight difference in the taxes, since the second policy would have had grown be about $1,000. But that is not a problem.
Willard R. Brumbaugh, LUTCF
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