Transfer-for-value rule in life insurance planning

By Brett Anderson

St. Croix Advisors

The transfer-for-value rule is an important, yet often over looked, component of life insurance planning, particularly in the business spectrum. Enacted to prevent tax-free windfalls from life insurance policy speculation, the transfer-to-value rule could come into play without you even knowing it.

Investopedia defines the rule as, “The stipulation that, if a life insurance policy (or any interest in that policy) is transferred for something of value (money, property, etc.), a portion of the death benefit is subject to be taxed as ordinary income. This portion is equal to the death benefit minus the item(s) of value, as well as any premiums paid by the transferee at the time of the transfer.”

There are some exceptions to the rule (particularly applicable in the business environment). According to Glenn E. Stevick Jr.’s Advisor Today article, “The Transfer-for-Value Rule,” the five exceptions are:
    1. Transfers to the insured,
    2. Transfers to a partner of the insured,
    3. Transfers to a partnership in which the insured is a partner,
    4. Transfers to a corporation in which the insured is a shareholder, and
    5. Transfers in which the transferee’s basis in the transferred policy is determined by reference to the transferor’s basis.
While examples of the above abound, examples of situations in which people assumed they were exempt, but actually weren’t, are just as prevalent. Therefore, if you’re facing a situation that involves a transfer of a life insurance policy, your best bet is to tread carefully and make sure you ask for assistance from your tax advisor.