Andy asks: I read with interest the replied on Estate tax TOD/POD and am wondering if the same reasoning applies to life insurance benefits that designate a specific beneficiary......
In other words, is it possible to avoid taxes and debts against the estate by buying a life insurance policy and designating a beneficiary.?????
No. Life insurance proceeds are subject to the same clawback rules as any other asset of the Estate. Life insurance policies with a named beneficiary avoid probate, that's all.
Adam has a son, Bob. If Bob buys a life insurance policy on Adam's life, Bob is the owner and can name anyone (including himself) as beneficiary. As long as the premiums are less than the annual gift tax exclusion, Adam can pay the premiums for Bob. When Adam dies, Bob collects cash, free of estate taxes and income taxes.
Assuming Adam is married, doesn't smoke, and is in good health, $25000 per year buys a buckedload of term insurance.
Adam can get the same money out of his estate by simply paying Bob the annual exclusion amount each year (currently $13,000) and letting Bob spend it on whatever he wants. From the standpoint of Adam's finances it will be the same either way.
Remember that if Adam gives Bob money for insurance premiums, that reduces his annual exclusion, and additional gifts to Bob during the same year will be subject to gift tax.
But that doesn't answer the question of whether the IRS or any of Adam's other creditors can get at the life insurance proceeds if Adam's estate isn't large enough to pay its bills. As a practical matter creditors don't seem to go after that kind of assets when they aren't paid by an estate.
But the transfers to Bob in your example meet the traditional definition of a fraudulent transfer - a transfer for less than full consideration, which resulted in the transferor's inability to pay all his bills when they came due. As a fraudulent transfer (even though it's not actually fraudulent - that's just what they call it) Adam's creditors (and that would include the IRS) can go after the gifts made to Bob, or the proceeds of those gifts.
If *Bob* owns the policy on Adam's life (as posited by the person Stuart is replying to), then the proceeds are NOT part of Adam's estate at all and are not subject to credit attachment or estate tax -- because they are Bob's asset!
If Bob owns the policy on Adam's life, but the money to pay the insurance premiums came from Adam, then if Adam's estate were insolvent his creditors would have a credible claim against the insurance death benefit as a fraudulent transfer.
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