Life Insurance And Title 19: What You Need To Know

Life insurance proceeds are generally not taxable, but there are certain situations where the beneficiary may be taxed on some or all of the proceeds. For example, if the policyholder elects to delay the benefit payout and the money is held by the insurance company for a given period, the beneficiary may have to pay taxes on the interest generated. If the policyholder names their estate as the beneficiary, the person inheriting the estate may have to pay estate taxes. To avoid paying taxes on life insurance proceeds, individuals can transfer ownership of the policy to another person or entity, or set up an irrevocable life insurance trust (ILIT). Title 19, also known as Medical Assistance or Medicaid, is a federal-state welfare program that provides funding for nursing home and assisted living care for individuals who meet certain income and asset requirements. While life insurance proceeds are generally not taxable, it is important to understand the specific regulations and requirements of Title 19 to determine if and how life insurance proceeds may be treated differently for individuals receiving assistance under this program.

Naming a beneficiary

There are two types of beneficiaries: primary and contingent. A primary beneficiary is the person or people first in line to receive the death benefit from your life insurance policy. Typically, this is a spouse, child, or other family member. In the event that your primary beneficiary dies before you, or at the same time as you, you can also name a secondary or contingent beneficiary. This is a backup beneficiary who will receive the death benefit if the primary beneficiaries are all deceased.

You can name multiple people as beneficiaries, but you must then decide how you want the money to be split between them. Usually, this is done by percentage. For example, you could divide the benefit 50/50, 65/35, or 50/25/25, etc.

It is important to keep your beneficiary designations up to date, especially if your life circumstances change (e.g. marriage, divorce, birth of a child). You can change beneficiaries at any time, although in some cases, such as specific terms of a divorce, you may need the current beneficiary's consent to do so.

If you do not name a beneficiary, it may be unclear who is entitled to the funds, which can delay the benefit payment. In this case, the money will likely be held in probate, a legal process where a court determines how to distribute your assets. To avoid this, you should carefully consider who you want to receive the payout from your life insurance policy and designate them as your beneficiary.

Life insurance and estate taxes

Life insurance proceeds are generally not subject to income or estate taxes. However, there are certain scenarios in which they can be taxed.

Firstly, if the payout is structured to be made in multiple payments, these payments may be taxable. For example, if the beneficiary receives an annuity over their lifetime, the payments may include proceeds and interest, which can be subject to taxes.

Secondly, if the policyholder has withdrawn money or taken out a loan against the policy, and the amount withdrawn or loaned exceeds the total amount of premiums paid, then the excess amount may be taxable.

Thirdly, if the policyholder surrenders their policy, any funds received over the policy's cash basis will be taxed as regular income.

Fourthly, in the case of an employer-paid group life plan, the Internal Revenue Service (IRS) may consider payouts over $50,000 to be taxable. Otherwise, the death benefit is usually paid to beneficiaries tax-free.

Lastly, and most significantly, if the death benefit and the total value of the deceased's estate exceed the federal estate tax threshold, currently set at $12.92 million (as of 2023), then estate taxes must be paid on the proceeds over this limit. This is determined by Section 2042 of the Internal Revenue Code, which states that the value of life insurance proceeds is included in the gross estate if payable to the estate or if the deceased had any ownership rights to the policy at the time of death.

To avoid estate taxes, individuals can transfer ownership of their life insurance policies to another person or entity, or establish an irrevocable life insurance trust (ILIT). However, the three-year rule applies in these cases, meaning that if the original policyholder dies within three years of the transfer, the proceeds will still be included in their estate and taxed accordingly.

Transfer of ownership

The policy owner is the person who controls a life insurance policy during the insured person’s lifetime. They can be the insured person or someone who purchased life insurance for someone else, such as a child or partner. The owner retains complete control over the policy and can decide to cancel, surrender, or gift the policy to someone else. They also have the right to change the policy beneficiaries or update the allocations of death benefits.

There are several ways to transfer ownership of a life insurance policy, depending on the specific circumstances and the type of policy involved. Here are some common methods:

Absolute Assignment

Absolute assignment involves transferring all rights and ownership of a life insurance policy from yourself to someone else or a legal entity. This transfer is usually permanent and irrevocable. If you use absolute assignment to transfer policy ownership, you must notify your insurer, who will provide you with the necessary ownership forms.

Change of Beneficiary

Instead of transferring ownership, the policyholder can change the beneficiary designation on the policy. By changing the beneficiary, the policy proceeds will be paid directly to the new beneficiary upon the insured's death, effectively redirecting the benefits to someone else.

Sale or Gift

The policyholder may choose to sell the policy to another person or entity for a negotiated price. Alternatively, the policyholder may choose to gift the policy to another individual or entity.

Trust

A life insurance policy can be transferred to a trust, where the trust becomes the new policy owner. This can provide various estate planning benefits, such as facilitating the management and distribution of policy proceeds according to the trust's terms.

Corporation or Business

In some cases, a corporation or business entity may own a life insurance policy for purposes like key person insurance or executive benefits. If the ownership structure of the company changes, the policy ownership may need to be transferred accordingly.

It's important to note that the laws governing life insurance and Title 19 (Medicaid) vary from state to state and are complex. Anyone thinking about planning for Title 19 eligibility or applying for benefits should seek professional advice tailored to their unique situation.

Life insurance and income tax

Life insurance proceeds are generally not subject to income taxes or estate taxes. However, there are certain exceptions. The type of policy, the size of the estate, and the method of payout can determine whether or not life insurance proceeds are taxed.

If you are the beneficiary of a life insurance policy, you do not need to include the payout in your gross income and you do not need to report it. However, if the policy was transferred to you for cash or other valuable consideration, the exclusion for the proceeds is limited to the sum of the consideration you paid, additional premiums you paid, and certain other amounts. There are some exceptions to this rule. Generally, you report the taxable amount based on the type of income document you receive, such as a Form 1099-INT or Form 1099-R.

If you are the policyholder who surrendered the life insurance policy for cash, you may be taxed on the proceeds if the amount you received is more than the cost of the policy. If you withdraw or take out a loan against your whole life policy's cash value, you may be taxed on any amount that exceeds your cumulative premium payments. If you borrow against the cash value and the loan is still outstanding when the policy is terminated or surrendered, the loan amount in excess of the cumulative premiums may be subject to income taxes.

If you surrender your whole life insurance policy, you may be taxed on the proceeds if they exceed the cumulative premiums. If you sell your whole life policy, you may be taxed on the sales proceeds if they exceed your cumulative premiums minus the portion of your premiums attributed to the cost of insurance.

Some life insurance companies offer dividends to whole life insurance policyholders, which are essentially a return of some portion of your premium dollars. You generally don't pay taxes on these dividends. However, if you let the insurer keep your dividends in exchange for interest, then you may pay income tax on the interest.

Title 19 eligibility

Asset Requirements:

To qualify for Title 19 benefits, applicants must meet certain asset limit requirements. An asset assessment, or "snapshot", is taken as of the day an individual enters a medical institution. For a single person, the asset limit is $2,000 in "countable" assets. Spousal impoverishment rules allow a couple to keep some of their assets and still be eligible for Title 19. The asset limit for a couple is $2,000 plus one-half of the "snapshot" assets, with a minimum of $50,000 and a maximum of $126,420. Please note that these amounts are subject to change.

Exempt Assets:

Certain assets are exempt from the "countable" assets and are not included in the asset limit requirements. These include:

• Homestead: A homestead of any value is exempt if a spouse, minor children, or dependent relative lives in it, or if the individual entering the nursing home intends to return home. The home equity exemption is limited to $750,000 unless a spouse, minor child, or disabled adult child is lawfully residing in the home.
• Automobile: One automobile per household is excluded, regardless of value, if it is used for transportation by the eligible individual/couple or a member of their household.
• Household and personal possessions: Possessions of a reasonable value for a single person; no limit on value for a married person.
• Pre-paid burial arrangements: If married, both spouses may own burial arrangements.
• Life Insurance: A $1,500 face value policy is exempt. If married, each spouse may own a $1,500 face value life insurance policy. If the face value is above $1,500, the cash value is considered a countable asset.

Income Requirements:

In addition to asset requirements, Title 19 applicants must also meet certain income requirements. For a single person on Title 19, all income except a $45 per month personal allowance and money for private health insurance or Medicare premiums will typically be paid to the nursing home for care. However, if a doctor certifies that the person is likely to return home, they may keep some additional income to maintain the home.

For married couples, income can be allocated to the spouse still residing in the community to bring their income up to a certain limit. Income can also be allocated to a dependent child or other dependent family member. Additionally, the community spouse may accumulate assets above the asset limit after the institutionalized spouse is on Title 19.

Frequently asked questions