When business and family relationships change, people may need to move a life insurance policy from one person or entity to another.
Typically, when ownership of a life insurance policy changes, the original owner reports a fully taxable gain, which is calculated by subtracting the owner’s adjusted cost basis (ACB) in the policy from the proceeds made when disposing of the policy.
Unfortunately, this process only recognizes gains for tax purposes, not losses.
The original owner also has to file a form with the life insurance carrier to register the change in title. The form identifies the new owner, the relationship between the old and new owners, and the transaction’s value.
There are four exceptions. And, in those cases, the policy can be transferred with no immediate tax consequences.
1. Transfer to a spouse or common-law partner. The spouse handing off the policy is deemed to receive proceeds of disposition equal to its Adjusted Cost Basis; the receiving spouse is deemed to pay an equal amount.
Tax-deferred transfers between spouses or partners may occur while both are alive, or between a deceased’s estate and the survivor. When the transfer is between spouses or partners, there’s an automatic rollover, unless they elect to opt out.
2. Transfer of a policy on the life of a child. This can be a valuable opportunity for parents who purchase a policy on a young child and later transfer ownership to that child when he or she is an adult.
Grandparents can also purchase a policy on the life of their grandchild, and later transfer that policy to the grandchild’s parents. This can help ensure control of the policy remains with someone mature until the grandchild is old enough to take ownership of the policy.
This can be done while the parent or grandparent is alive and can sign the forms to register a change in ownership with the life insurance carrier. It’s also important to do it while they’re alive because there can’t be a rollover from either the parent or grandparent’s estate to the child. Naming the child as the contingent owner of the policy will allow him or her to receive it on the death of the older generation.
3. Transfer from trust to capital beneficiary. A policy can be owned by a trust, which then rolls it over to the beneficiary. That beneficiary would assume the trust’s Adjusted Cost Basis in the policy for tax purposes.
4. Corporately owned policies. Transfers are rolled over when a policy is owned by a corporation that’s being amalgamated or wound up. In an amalgamation, the new company is considered to be a continuation of the merged companies and the policy moves at its Adjusted Cost Base. In a windup, the parent company takes over the subsidiary’s assets and assumes the policy at the subsidiary’s ACB.