Life Insurance Payouts: Gifts Or Not?

Life insurance policies are typically taken out by individuals who expect that an insurer will pay a sum of money known as a death benefit to beneficiaries in the event of their death. However, it is possible to give life insurance as a gift, either by designating the gift recipient as the owner or beneficiary of an existing policy or by establishing a new policy for them. In the latter case, the gift-giver must provide proof of insurable interest, the recipient's consent and personal information, and potentially a medical exam and other information.

When an insured person dies, the death benefit is considered a taxable gift from the policy owner to the beneficiary. If the owner, insured, and beneficiary are three different people, the gift occurs when the insured dies, and the death benefit is treated as a taxable gift from the policy owner to the beneficiary.

Gifting your own life insurance

Designating the Recipient as a Beneficiary

You can name the recipient as a beneficiary of your life insurance while retaining ownership of the insurance policy. In this case, the beneficiary will typically receive the death benefit as a lump-sum payment after your death. However, you can change your mind and name a different beneficiary or multiple beneficiaries later on. This option gives you control over the policy while you are alive.

Transferring Ownership of Your Policy

Transferring ownership of your policy to the recipient is a more complex option. Here, the recipient becomes the owner of the policy and has the authority to make changes, name beneficiaries, etc. While it is possible to continue paying premiums on the transferred policy to keep it active, it is essential to confirm this with your insurance provider to avoid any misunderstandings.

Gifting your life insurance policy can be a valuable present, offering financial security to your loved ones in the event of your death. It is certainly not a conventional gift, but it can be a thoughtful way to show your care and support.

Buying a new policy as a gift

Life insurance can be a valuable gift, offering financial security to your loved ones in the event of your death. While most people buy life insurance for themselves, it is possible to purchase a new policy for someone else. Here are some reasons why you might consider buying a new life insurance policy as a gift:

• Guarantee of Insurability: Certain illnesses and life events can make individuals ineligible for life insurance. By buying a policy for your loved one, you can ensure they are insured before any health issues arise that might affect their eligibility. You may also be able to purchase a guaranteed insurability rider, which allows for amendments to the policy without the need for a second medical exam.
• Protection Against the Unknown: It can be difficult to think about the death of a loved one, but life insurance provides crucial financial support in the event of a tragedy. By buying a policy for someone else, you can help ensure their financial security, regardless of future health issues.
• Potential for Other Payments: Some life insurance policies offer financial benefits beyond the death benefit. Certain policies include a cash value component that can supplement retirement income or be used for other purposes.

If you decide to purchase a new life insurance policy as a gift, there are several steps you will need to take:

• Shop Around: Compare different life insurance policies to find one that meets your needs and budget. Consider factors such as the type of policy (whole life or term), the coverage amount, and the cost of premiums.
• Demonstrate Insurable Interest: To purchase a policy for someone else, you must demonstrate an insurable interest in the recipient. This means you would suffer financial loss or hardship if the insured person passed away.
• Gather Necessary Information: You will need to provide personal information about the recipient, including their full name, date of birth, Social Security number, and similar data.
• Obtain Recipient's Consent: If you are buying a policy for an adult, you must obtain their consent. For a minor, you will need the consent of their parent or guardian.
• Medical Exam: Depending on the policy and provider's guidelines, the recipient may need to undergo a medical exam.
• Complete Registration and Purchasing: Work with the chosen provider to finalise the registration and purchasing process for the policy.
• Maintain Premium Payments: To keep the policy active, ensure that premiums are paid regularly.

When buying life insurance as a gift, it is important to consider the tax implications. If you are gifting a whole life insurance policy, it may be excluded from the total estate value if transferred at least three years in advance. Additionally, if you are paying premiums on behalf of the recipient, you should file a form with the IRS declaring the gift amount.

How to buy a policy for someone else

To buy a life insurance policy for someone else, you need to prove that you have an insurable interest and get the consent of the person you are insuring. Insurable interest means that you can prove to an insurance provider that it would be financially harmful to you if the person you aim to take a policy out for passes away. In other words, you must prove that you rely on someone else while they are alive and would suffer financially if that person died.

The person the life insurance policy is for must be present for every step of the application process. You will need to fill out a form that clarifies your benefits and how the life insurance policy functions. The life insurance application may ask you who the beneficiary is, who the policy is for and how much coverage you would like. The person being insured may be required to have a medical exam, or they may be able to answer a set of questions instead.

There are a handful of people you may be able to prove you have an insurable interest for more easily:

• Your spouse: It’s not uncommon to take out a life insurance policy for a spouse if you and your loved ones rely on them financially.
• Your business partner: If you have built a business with someone else and they were to pass suddenly, it may leave your venture in a tough spot.
• Your parents: If you rely on your parents for financial support or may be responsible for their final expenses, it may make sense to help them get a life insurance plan.
• Your child: Instead of insuring someone you rely on financially, the reasons for taking a life insurance policy out on a child are different. Instead, you can help your child get life insurance early in life if they have a known health issue or are at risk of developing one. Health problems can make getting a life insurance plan more difficult, so getting one early can help guarantee your child is insurable.

Primary and contingent beneficiaries

When setting up a life insurance policy, it's important to designate both primary and contingent beneficiaries. This ensures that your assets are handled according to your wishes.

Primary Beneficiaries

The primary beneficiary is the first person or entity in line to receive the death benefit from your life insurance policy. You can have more than one primary beneficiary and specify how the assets should be divided among them. It is common to name a spouse, children, or other family members as primary beneficiaries.

Contingent Beneficiaries

A contingent beneficiary, also known as a secondary beneficiary, is the person or entity that stands to inherit the assets if the primary beneficiary is unable or unwilling to do so. They are essentially a backup to the primary beneficiaries. Contingent beneficiaries only receive the assets if the primary beneficiary is deceased or otherwise unable to claim the inheritance. You can designate multiple levels of contingent beneficiaries to ensure a clear line of succession.

Why Both Designations Are Important

Naming both primary and contingent beneficiaries is crucial for comprehensive estate planning:

• Avoid Probate: Properly designated beneficiaries can help avoid the lengthy and costly probate process.
• Ensure Wishes Are Fulfilled: Contingent beneficiaries ensure that your assets are distributed according to your wishes, even if the primary beneficiaries cannot receive them.
• Clarity and Security: Clear designations prevent disputes among potential heirs and provide peace of mind, knowing that your loved ones are taken care of.

How to name a beneficiary

Naming a beneficiary is an important part of owning life insurance. A beneficiary is the person or entity that receives the benefits from your policy or accounts when you die. It is a decision that should be carefully considered and regularly reviewed. Here is a step-by-step guide on how to name a beneficiary:

• Identify the type of beneficiary: There are two types of beneficiaries: primary and contingent. A primary beneficiary is the first in line to receive the death benefit, while a contingent beneficiary receives the benefit if the primary beneficiary is unable to or deceased. You can have multiple primary and contingent beneficiaries.
• Choose your beneficiary: The choice of beneficiary depends on your personal situation and preferences. Typically, beneficiaries are spouses, children, or other family members. However, you can also choose a close friend, a charitable trust, or even a pet (by setting up a trust with a guardian as the beneficiary). Consider who would benefit the most from the payout and who you want to provide for after your death.
• Obtain necessary consents: If you are purchasing a life insurance policy for another person and naming yourself as the beneficiary, you must obtain their consent. This is required if you have an insurable interest, meaning you depend on the individual financially and would be impacted by their death.
• Provide required information: When naming a beneficiary, you will need to provide specific information, including the full legal name of the beneficiary, their relationship to you, their Social Security number or Tax ID, contact information, and date of birth (especially if the beneficiary is a minor). Be as specific as possible to avoid disputes and ensure a smooth transfer of benefits.
• Fill out the necessary forms: Most financial services companies provide a form or website to designate your beneficiary. Contact your insurance provider to obtain the required form, typically called a "Change of Beneficiary" form.
• Submit the form and any additional documentation: Along with the change form, you may need to provide additional documents for verification, such as identification forms or legal papers. Follow up with your insurance provider to confirm that they have updated your beneficiary information accurately.
• Remember to update your beneficiary: It is important to regularly review and update your beneficiary designations, especially after significant life events such as marriage, divorce, the birth of a child, or the death of a loved one. Life insurance policies are separate from your will, so remember to update your will and any other relevant documents as well.

By following these steps, you can ensure that your life insurance benefits go to the right people at the right time and that your wishes are honoured.

Frequently asked questions