Who Gets Your Life Insurance Payout?

Life insurance is a crucial component of financial planning, and the selection of the owner and beneficiary is critical. The policyowner has complete control over the policy and is responsible for paying the premiums. The insured is the person whose life is covered by the policy, and the beneficiary is the person who receives the payout when the insured dies. While the owner and insured are frequently the same person, this is not always the case. The owner has the authority to transfer ownership and change beneficiaries. It is critical to review and update your policy on a regular basis to reflect any changes in your life, such as marriage, divorce, or the birth of a child.

Understanding the role of the policy owner

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 policy owner retains complete control over the policy and has several rights and responsibilities.

Rights of the policy owner

The policy owner has the right to:

• Name or change beneficiaries
• Transfer ownership
• Access the cash value and dividends, if applicable
• Decide the amount and length of coverage
• Renew or cancel the policy
• Update the frequency of payments

Responsibilities of the policy owner

The policy owner is responsible for:

• Paying the premiums
• Making timely payments

The policy owner and the insured are usually the same person, but sometimes they may be different. For example, a business might buy key person insurance on a crucial employee such as a CEO, or an insured might sell their own policy to a third party for cash in a life settlement.

The right to transfer ownership

The process of transferring ownership typically involves obtaining and filling out a change-of-ownership form from the insurance company or agent. The new owner's information, such as their name, relationship to the insured, and Social Security number, will be required. Additional information may be needed if transferring ownership to a business or trust. It is advisable to consult a financial professional to understand the potential tax implications of transferring ownership.

It is important to note that the transfer of ownership must occur at least three years before the previous owner's death to keep the policy out of their taxable estate. Since the date of one's death cannot be predicted, it is crucial not to delay this task if it is part of estate planning.

Furthermore, the right to transfer ownership allows policy owners to adapt to changes in their lives. For example, transferring ownership may be necessary if an attorney suggests creating a life insurance trust or if transferring ownership to a bank improves the chances of securing a business loan. By understanding and exercising their right to transfer ownership, policy owners can ensure that their life insurance policy aligns with their evolving needs and circumstances.

In summary, the right to transfer ownership is a vital aspect of owning a life insurance policy. It empowers the owner to make changes, ensure the policy's alignment with their interests, and facilitate effective estate planning. By following the necessary procedures and seeking professional advice, individuals can effectively exercise their right to transfer ownership and make informed decisions regarding their life insurance policies.

The right to change beneficiaries

The owner of a life insurance policy has the right to change the beneficiaries at any time, depending on the terms of the policy, without any penalty or fee. The owner should also be able to name a contingent beneficiary who will receive the death benefit payout if the primary beneficiary is deceased or unable to receive the funds.

To change the beneficiary of a life insurance policy, the owner needs to contact the insurance company. The process for changing a beneficiary may differ depending on the provider. Generally, the owner will need to fill out a change-of-beneficiary form, which includes information such as the policyholder's name, the new beneficiary's name, and the reason for the change. The owner may also need to provide a copy of the policyholder's death certificate if the beneficiary is being changed due to their death. Once the form is completed, the owner must submit it to the insurance company for approval.

It is important to keep life insurance beneficiaries up to date, especially if the owner's life circumstances have changed, such as getting married, divorced, or having a child. For example, if the owner has named a previous spouse as the beneficiary but has since remarried, they may want to update the beneficiary to their current spouse. If the owner doesn't keep their beneficiaries up to date, someone other than who they intended may receive the benefits.

The right to revoke the transfer of ownership

While the policy owner has the right to revoke the transfer of ownership, there are certain conditions and restrictions that apply. One important condition is the timing of the revocation. In the United States, the Internal Revenue Service (IRS) has a three-year rule for life insurance transfers. If the original owner passes away within three years of transferring the policy, the IRS will include the value of the transferred policy in their gross estate for tax purposes. This means that if the owner wishes to revoke the transfer to avoid estate taxes, they must do so at least three years before their death.

It is also important to understand the difference between permanent and term life insurance when considering the right to revoke the transfer of ownership. Permanent life insurance has no expiration date, and the insurance company will pay the death benefits regardless of when the insured person dies, assuming the owner has paid all the premiums. On the other hand, term life insurance provides coverage for a limited time, usually between 5 and 30 years, and the death benefits are paid only if the insured person dies during the coverage period. The type of insurance policy will impact the owner's rights and responsibilities, including the right to revoke the transfer of ownership.

In addition to the timing and type of policy, there are other factors that may influence the owner's ability to revoke the transfer. For example, if the owner transfers the policy to a trust, they may lose the ability to revoke the transfer. The specifics of the trust agreement and the applicable laws will determine whether the owner can regain ownership of the policy. It is always advisable to consult with a legal or financial professional before making any changes to a life insurance policy, including revoking the transfer of ownership.

The right to pledge the policy for a loan

The right to pledge a life insurance policy for a loan is one of the critical ownership rights of a life insurance policy. This right allows the policyholder to use the life insurance contract as collateral when taking out a loan from a bank or other financial institution. This means that the policyholder agrees to let the lender collect the outstanding loan balance from the death benefit of the life insurance policy if they pass away before the loan is fully repaid.

Pledging a life insurance policy as collateral can be an attractive option for individuals who need to access funds without risking their personal assets, such as their home or car. It is also a viable option for those with a low credit score, as the lender can rely on the policy's death benefit as a guarantee of repayment.

However, it is important to consider the risks associated with this type of financial arrangement. If the policyholder passes away before repaying the loan, the death benefit that their beneficiaries receive will be reduced, as the lender has the first right to collect the funds owed to them. Additionally, the policyholder must stay current on their insurance premium payments during the loan period, as failing to do so could have serious consequences.

The process of pledging a life insurance policy as collateral typically involves the following steps:

• Obtain a permanent life insurance policy that builds cash value, such as whole life or universal life insurance.
• Wait for the policy to accumulate sufficient cash value that can be used as collateral for the loan.
• Find a lender, such as a bank or other financial institution, that is willing to accept the life insurance policy as collateral.
• Complete the loan application process and provide information about the life insurance policy as collateral.
• Conditionally appoint the lender as the primary beneficiary of the policy's death benefit.
• Use the loan funds as needed and make regular repayments, including any interest, to the lender.

It is important to note that the policyholder must obtain the necessary authorisation from the lender if they wish to make changes to the life insurance policy during the loan period. This includes management acts such as switching policies or surrendering the policy.

Frequently asked questions