Transferring Your Life Insurance: Is It Possible?

Life insurance is a complex topic, and while it's possible to transfer the essence of a life insurance policy from one company to another, there are many factors to consider. The process involves transferring cash values from one policy contract to another, and it's important to follow the proper procedures to avoid problems and taxable gains. One way to do this is through a 1035 exchange, which allows for a tax-free transfer of assets if a like product is exchanged for another like product.

There are also different methods to transfer a policy's ownership, including absolute assignment, collateral assignment, and an irrevocable life insurance trust (ILIT). Absolute assignment involves an irreversible transfer of all rights and ownership to someone else or a legal entity, while collateral assignment is temporary and allows the policy owner to use their life insurance policy to obtain a loan. An ILIT is a type of trust that owns a life insurance policy as its primary asset and can be used to reduce or avoid estate taxes.

Additionally, employer-provided life insurance policies typically terminate when you leave a job, but some may be portable, allowing you to pay for the same coverage through a renewable term life policy or convert it into a permanent individual life insurance policy.

Before making any decisions, it's important to carefully consider your options and seek professional advice to ensure you're making the best choice for your circumstances.

Transferring employer-provided life insurance

If your employer's group life insurance is portable, you can choose to "port" your coverage, which means paying the premium yourself and having the option to renew or end your coverage as needed. Before porting your group policy, it is recommended to compare the potential cost with the cost of a standard term life insurance policy to determine the most suitable option.

Another option is to convert your employer-provided life insurance into a permanent individual life insurance policy. This option will result in higher premiums, as permanent coverage costs more than term coverage. It is important to compare the potential cost with rates for a standard whole life policy before making a decision.

In general, transferring a life insurance policy from one company to another is not possible due to underwriting and changing factors that can affect the cost, such as age and health conditions. However, policyholders can change their policy or obtain multiple life insurance policies if needed.

Transferring ownership of a life insurance policy

There are two ways to transfer policy ownership. The first is to transfer ownership of the policy directly to another adult. This includes the policy's named beneficiary. The second way is to create an irrevocable life insurance trust (ILIT). With an ILIT, ownership of the policy is transferred to the trust. However, if you get life insurance through your job, ownership rights may be non-transferable.

When transferring ownership of a life insurance policy to another adult, it is best to use transfer forms from your insurance company to ensure everything is clear. You can request a transfer form directly from your life insurance company. However, you may also have to change the policy to indicate that the insured is no longer the owner. After the transfer, the new owner is responsible for making all premium payments. If you continue to make the payments on the policy yourself, the IRS may view this as evidence that you are still the true owner. The IRS will then count any life insurance proceeds in your estate for tax purposes.

There are three requirements that must be satisfied to create a valid life insurance trust:

• It must be an irrevocable trust, meaning that the creator of the trust cannot alter it.
• The grantor (i.e. the creator) cannot be the trustee.
• The grantor must create the trust at least three years before their death.

There are some drawbacks to transferring ownership of a life insurance policy. For example, if you transfer your policy to someone else and continue to pay the premiums, the IRS may view this as evidence that you are still the true owner and count the policy in your estate for tax purposes. Additionally, transferring ownership of a life insurance policy to another adult is irreversible.

Switching life insurance providers

Medical Exams and Premiums:

A new provider will require a new medical exam, which could lead to a higher premium. Any new health issues will be taken into account, and there is a risk of being deemed uninsurable.

Contestability Period:

Switching providers will initiate another two-year contestability period. During this time, if the policyholder passes away, the insurance company has the right to investigate the claim before paying the beneficiary. The carrier may deny the claim or deduct premiums if they believe the customer provided incorrect information.

Upfront Fees:

Life insurance carriers often charge upfront fees when issuing a new policy, so you will likely have to pay these fees again when switching providers.

Tax Implications:

Changing your life insurance policy may result in new taxes. For example, transferring ownership of the policy to another party and naming a third individual as the beneficiary may result in a gift tax. If you surrender your original policy, the cash value may exceed the policy value, making the difference taxable.

Policy Conversion:

Before switching providers, explore the possibility of converting, replacing, or supplementing your existing policy to achieve the desired coverage. This option can help you avoid a new medical exam and contestability period.

Research and Comparison:

Take time to research potential new providers to ensure they align with your goals and values. Compare benefits, prices, and contractual language to make an informed decision.

Bundling Discounts:

Consider any bundling discounts you may be receiving with your current provider. Switching providers may result in losing these discounts, so explore options to bundle policies with the new provider to maintain savings.

Surrender Charges:

If you cancel your permanent life insurance policy, you may be charged a surrender fee. This fee decreases over time, but it's important to be aware of the potential cost before making a decision.

Alternatives to Switching:

Before switching providers, consider adjusting your current coverage or exploring conversion or renewal options with your current provider. You may also choose to purchase a second policy and maintain both for robust coverage.

Tax-free transfer of assets

Life insurance can be a great way to provide for your family and loved ones after your death. However, it's important to understand the tax implications of your policy to ensure that your payout doesn't increase your estate tax liability. One way to do this is through a tax-free transfer of assets.

Transfer of Ownership

One way to avoid taxation on your life insurance proceeds is to transfer ownership of the policy to another person or entity. This can be done by choosing a competent adult or entity, such as the policy beneficiary, and requesting the proper assignment or transfer of ownership forms from your insurance company. It's important to note that new owners must pay the premiums on the policy, and you will give up all rights to make changes to the policy in the future. Obtaining written confirmation from your insurance company is crucial as proof of the ownership change.

Irrevocable Life Insurance Trust (ILIT)

Another way to remove life insurance proceeds from your taxable estate is to create an irrevocable life insurance trust (ILIT). With this method, you transfer ownership of the policy to the trust, and you are no longer considered the owner. Therefore, the proceeds are not included as part of your estate. It's important to note that you cannot be the trustee of the trust and you may not retain any rights to revoke the trust. This method allows you to maintain some legal control over the policy and ensure that all premiums are paid promptly.

Timing of Transfer

When transferring ownership of a life insurance policy, it's essential to keep in mind the three-year rule. According to this IRS rule, if the transfer occurs within three years of the original owner's death, the proceeds from the policy will be counted in the decedent's estate for tax purposes. Therefore, it's advisable to transfer ownership sooner rather than later to ensure that three years pass before your death, reducing the tax burden on your estate.

Incidents of Ownership

Even after transferring ownership, the person covered by the policy must relinquish any "incidents of ownership" to avoid taxation. This includes the power to cancel, surrender, or convert the policy, use it as collateral, change the beneficiary, or select the method of payment. If any of these incidents are retained, the IRS will count the policy as part of the estate for tax purposes.

Gift Tax Exemption

It's important to be mindful of the federal gift tax exemption when transferring a life insurance policy. Any gifts over a certain amount may be subject to the federal gift tax. Therefore, if the value of the policy exceeds the exemption amount, it will be taxed when the policy pays out. The exemption amount for 2022 is $16,000, and for 2023, it is $17,000.

Transfer-for-Value Rule

Congress has implemented the transfer-for-value rule to discourage speculation and tax avoidance through the transfer of life insurance policies. This rule states that if the recipient of a life insurance policy transfers the benefit to another party, the tax-exempt status of the policy is removed, and the purchaser must pay income tax on a portion of the death benefit. This rule applies if the policy is transferred in return for valuable consideration, such as monetary payments or a reciprocal agreement. However, there are exceptions to this rule, such as policy transfers to the insured, a partner of the insured, or a corporation in which the insured is an officer or shareholder.

Transferring life insurance after a change in health

Life insurance policies are not one-size-fits-all. Your needs may change over time, and you may find yourself in a position where you need to adjust your death benefit or select another type of policy that better suits your requirements.

If your health has changed, you may be able to switch life insurance policies or providers to find a policy that fits your current and future needs. Here are some things to consider when transferring life insurance after a change in health:

Understand the impact of changing health on your policy:

Your health status is a critical factor in determining the cost and availability of life insurance policies. Any new health issues or improvements in your health can significantly affect your options. New health issues may result in a more expensive policy, while improvements in your health may make you eligible for a better premium.

Consult with your current provider:

Before making any decisions, talk to your current insurance provider to discuss your updated life insurance needs. They may be able to make adjustments to your existing policy, such as changing it from term to permanent, or offer a new policy that meets your requirements.

Be aware of medical exams:

Medical exams are typically required when applying for a new life insurance policy. The results from your existing policy cannot be carried over, and the new provider will consider your current health status and medical history. This means any changes in your health since the original policy was issued will be taken into account.

Consider the financial implications:

Switching to a new life insurance policy may result in higher upfront fees and premiums. Additionally, there may be tax consequences associated with dropping your old policy, so be sure to consult a financial expert or tax accountant.

Understand the waiting period:

Most new life insurance policies have a waiting period before certain death benefits become effective. Make sure you understand the waiting period and any other clauses or exclusions that may reset when you change policies, such as the contestability period and suicide clause.

Explore alternatives:

Before cancelling your existing policy, consider alternatives such as adjusting your current coverage, converting or renewing your term policy, or purchasing a second policy to overlap with your existing one. These options can provide you with the desired coverage without having to switch providers completely.

Frequently asked questions