Alyssa Lane
Life insurance is a financial asset, but it is not typically considered a tangible asset. A tangible asset is a physical asset that has value and can be touched or seen, such as real estate, vehicles, or equipment. Life insurance, on the other hand, provides a death benefit to the policyholder's beneficiaries upon their death. While it can be an important part of financial planning, it is not a physical asset and therefore does not fall under the category of tangible property. However, in certain contexts, such as divorce proceedings or estate planning, the treatment of life insurance proceeds can become complex and may vary depending on state and federal laws.
What You'll Learn
Life insurance as an asset in divorce
Life insurance is often overlooked during divorce proceedings, but it is an important part of the process, especially if children are involved.
Types of Life Insurance
Firstly, it is important to understand the different types of life insurance policies. Term life insurance is a form of protection that lasts for a set period, usually 10 to 30 years, and pays a death benefit to your beneficiary if you die while the policy is active. Whole life insurance, on the other hand, is a permanent life insurance policy that includes a cash value component. A portion of the premiums goes into a tax-deferred savings account, which earns interest over time and can be withdrawn from while the policyholder is still alive.
Life Insurance as an Asset
Whether or not life insurance is considered an asset depends on the type of policy and the state you live in. Term life insurance is generally not considered an asset because it has no cash value and does not provide any financial benefit to the policyholder during their lifetime. In contrast, whole life insurance and other types of permanent life insurance with a cash value component are typically considered assets. This is because the policyholder can access and benefit from the cash value of the policy while they are still alive.
During a divorce, any life insurance policies with a cash value are usually listed among the marital assets to be divided. This means that each spouse would receive half of the cash value from the policy. If there is no cash value component to the policy, then it is unlikely to be considered an asset. However, this may vary depending on the state and the specific circumstances of the divorce.
Beneficiary and Ownership Changes
In the event of a divorce, it is important to update your life insurance policy to reflect the change in marital status. This includes changing the beneficiary, especially if there are no children involved, as you likely no longer want your ex-spouse to profit from your death. Most life insurance policies are revocable, meaning the beneficiary can be changed at any time. However, some policies appoint irrevocable beneficiaries, in which case the beneficiary cannot be changed.
It is also important to review ownership of the policy. In some states, an ex-spouse may not be allowed to stay on a life insurance policy since they no longer have an insurable interest. However, if there are children involved and one spouse takes primary custody, it may be a good idea to maintain a life insurance policy on the other spouse to protect alimony and child support income.
Other Considerations
When dealing with life insurance during a divorce, it is important to consider any surrender charges that may reduce the surrender value of the policy. Additionally, it may be necessary to provide documentation of all current insurance policies, assets, and liabilities, depending on the requirements of the state in which you reside. Consulting with an attorney and a financial planner can help ensure that all necessary considerations are made and that your interests are protected.
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Life insurance and federal income tax
Life insurance is a financial asset, but it is not considered a tangible asset as it does not have a physical form and cannot be touched or seen. However, it can be an important part of a person's financial plan and estate planning strategy, providing financial protection to their loved ones in the event of their death.
When it comes to federal income tax, life insurance proceeds are generally not taxable. If you receive life insurance proceeds as a beneficiary due to the death of the insured person, you don't have to include them in your gross income or report them. However, there are a few exceptions to this rule:
- Transfers-for-value: If a life insurance policy is transferred for cash or other valuable consideration, the exclusion for the proceeds is limited to the sum of the consideration paid, additional premiums paid, and certain other amounts.
- Employer-owned life insurance: If the beneficiary of a life insurance policy is the employer, the proceeds may be taxable under certain conditions. For example, if the deceased employee was not a recent employee or if the proceeds are not used to benefit the family members of the insured or redeem their financial interest in the business.
- Interest: Any interest received on life insurance proceeds is generally taxable and should be reported.
It is important to note that different types of life insurance policies may have different tax implications. For example, a Modified Endowment Contract (MEC) is a type of life insurance policy that receives less favorable tax treatment than a non-MEC policy. Additionally, whole life insurance and other types of permanent life insurance with a cash value component are considered assets for tax purposes, as the policyowner can withdraw funds from the policy during their lifetime.
In summary, while life insurance proceeds are generally not taxable, there are certain situations and exceptions that may apply. It is always recommended to consult with a tax professional or financial advisor to understand the specific tax implications of life insurance in your particular circumstances.
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Life insurance and estate tax
Life insurance proceeds are generally not considered taxable income for the beneficiary. However, there are certain scenarios where life insurance proceeds can be taxed as part of the estate tax.
Firstly, if the payout is structured as multiple payments over the life of the beneficiary, these payments can be subject to taxes. For example, if the beneficiary receives the proceeds as an annuity, the payments may include interest, which can be taxable.
Secondly, if the policyholder has withdrawn money or taken out a loan against the policy, and the amount withdrawn exceeds the total amount of premiums paid, then the excess may be taxable.
Thirdly, and most relevant to the topic, if the life insurance proceeds are included as part of the deceased's estate, and the total value of the estate exceeds certain thresholds, estate taxes may apply. In the US, as of 2023, the federal estate tax threshold is $12.92 million. If the value of the estate, including life insurance proceeds, exceeds this limit, estate taxes must be paid on the amount over the threshold.
It is important to note that there are ways to structure life insurance policies to avoid them being included in the taxable estate. One method is to ensure that the estate is not designated as the beneficiary of the policy. Another approach is to transfer ownership rights to another person or entity, although this must be done at least three years before the policyholder's death to avoid a "claw-back" provision.
Life insurance can be an important tool in estate planning, providing liquidity to pay estate taxes or leaving a legacy to heirs. However, careful planning is necessary to ensure that the proceeds are not subject to unnecessary taxation.
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Life insurance and probate
Life insurance proceeds are not considered tangible property. A life insurance policy is a financial asset, but it is not typically considered a tangible asset as it is not a physical asset that can be touched or seen.
Life insurance proceeds generally do not go through probate. This is because the money in a life insurance policy is not a part of your estate and is held in trust by the insurance company for the beneficiaries of the policy. When the insured passes away, the insurance company pays the beneficiaries of the policy directly.
However, there are two scenarios in which a life insurance policy will go through probate:
- Beneficiary pre-deceases the policyholder: If the beneficiary of a life insurance policy dies before the insured, the proceeds will be paid out to the insured's estate (unless the insured changed beneficiaries before their death).
- Life insurance payable to the insured's estate: In some circumstances, it may be sensible to have a life insurance policy made payable to the estate of the insured. In this case, when the insured passes away, the life insurance money will go into their estate.
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Life insurance and community property
Life insurance is a financial asset, but it is not typically considered a tangible asset. A tangible asset is a physical asset that has a value and can be touched or seen. That being said, a life insurance policy can still be an important part of a person's overall financial plan and estate planning strategy.
In the United States, nine states are community-property jurisdictions: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. In these states, property accumulated during marriage is to be split equally. However, property owned before marriage or after a separation is considered separate property. In community-property states, married couples are joint owners of most things acquired during the marriage unless stated otherwise in a legal document.
Community property rules can often impact mobile couples without their realizing it. For example, if a couple moves from a community-property state to a non-community-property state, their property may still be considered by the Internal Revenue Service (IRS) to be community property unless the couple does something to the contrary.
In a community-property state, if a life insurance policy was purchased with community funds and the insured spouse dies, one-half of the proceeds will be included in the insured's federal gross estate. In the case where the insured dies owning the policy and names their probate estate beneficiary, the insured's executor receives the full amount of the policy proceeds, only one-half of which is includable in the insured's gross estate. The surviving spouse has a legal claim to one-half of the proceeds under community property principles, since one-half of the proceeds are deemed to belong to them.
A strange result can occur when community funds are used to purchase a policy and the surviving spouse is not made the beneficiary of the full proceeds. In this case, the IRS believes that although one-half of the proceeds are includable in the deceased spouse's federal gross estate, the surviving spouse may have made a gift of that spouse's half of the proceeds to the named beneficiary.
When it comes to life insurance and community property, it is important to understand the specific laws and regulations of the state in which you reside. Each community-property state may have different approaches and nuances in how they treat life insurance policies and proceeds.
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Frequently asked questions
No, life insurance is not typically considered a tangible asset. A tangible asset is a physical asset that has a value and can be touched or seen, such as real estate, vehicles, furniture, equipment, and inventory. A life insurance policy is a financial asset that provides a death benefit to the policyholder's beneficiaries upon their death.
Term life insurance is not considered an asset because it does not have a cash value component. Whole life insurance and other types of permanent life insurance with a cash value component are considered assets because you can withdraw funds from your policy while you're alive.
Generally, life insurance proceeds received as a beneficiary due to the death of the insured person are not taxable income and do not need to be reported. However, any interest received on the proceeds is taxable.
This depends on a variety of factors, including state and federal laws, as well as the presence of pre- or post-nuptial agreements. In community property states, a life insurance policy will almost certainly be subject to distribution in a divorce if the couple paid premiums with joint funds while married. Federal laws also dictate that group insurance, policies for military service members, and federal employee plans are usually treated differently in cases of divorce, and an ex-spouse is typically entitled to life insurance money derived from these policies.
Yes, the beneficiary of a life insurance policy can be disputed, particularly in cases of divorce. Once a divorce is final, some states automatically invalidate the benefit to an ex-spouse, which is called revocation upon death.
