What Are Incidents of Ownership in Life Insurance?
Holding certain rights over a life insurance policy can cause its value to be included in your estate. Learn how to structure ownership effectively.
In life insurance, “incidents of ownership” refers to the collection of rights and powers an individual holds over a policy, giving them control over its economic benefits. This control is what defines ownership, even if the powers are never used. Holding these rights is an important part of estate planning because it can have significant financial consequences, particularly for federal estate taxes.
Estate Tax Implications of Ownership
The primary consequence of holding incidents of ownership at the time of death relates to federal estate taxes. Under Internal Revenue Code Section 2042, if a person possesses any of these rights, the full death benefit from the life insurance policy is included in their gross estate. A gross estate is the total value of all assets a person owns at death, which is used to calculate potential estate tax liability.
This inclusion can push an estate’s value over the federal estate tax exemption threshold, which is $13.99 million per individual for 2025. If the total value of an estate, including the life insurance proceeds, exceeds this amount, the excess may be subject to federal estate tax with rates as high as 40%.
The Internal Revenue Service (IRS) looks at who has the power to affect the policy, not just who pays the premiums. Even if you do not technically own the policy on paper, retaining certain controls means the proceeds will likely be counted among your assets. This makes the proper structuring of policy ownership a point of focus for individuals with sizable estates.
Rights That Constitute Ownership
The IRS defines several specific rights that constitute incidents of ownership, and holding even one of them is enough to trigger estate tax inclusion. These rights center on the ability to control the economic benefits of the policy. The simple capacity to exercise these powers is what matters, not whether you actually do so.
Changing the Beneficiary
The power to change who receives the death benefit is a primary incident of ownership. If you have the authority to remove one beneficiary and name another, you have retained control over the policy’s proceeds. For example, if you initially name your spouse as the beneficiary but reserve the right to change that designation to your child, you hold an incident of ownership.
Surrendering or Canceling the Policy
The right to surrender the policy for its cash value or to cancel it outright is another incident of ownership. This gives the policyholder the ability to terminate the contract and receive its current equity. This action directly prevents the beneficiaries from ever receiving the intended death benefit.
Assigning the Policy
Having the right to assign the policy to another person or entity, or to revoke a previous assignment, is a clear indicator of ownership. An assignment is a complete transfer of the policyholder’s rights to someone else. The ability to make or undo such a transfer demonstrates control over the policy.
Pledging the Policy for a Loan
Using the life insurance policy as collateral to secure a loan is another right the IRS views as an incident of ownership. When a policy is pledged, it is used to guarantee repayment of a debt. This ability to leverage the policy for personal financial benefit is a direct economic advantage.
Borrowing Against Cash Value
Many permanent life insurance policies accumulate a cash surrender value, and the right to borrow against this value is an incident of ownership. Taking a policy loan provides the owner with access to the policy’s equity for any purpose. This power to extract economic value from the policy is a clear ownership right.
Other Controlling Actions
Other rights can also be considered incidents of ownership. This can include the right to select how the death benefit is paid out to beneficiaries, known as selecting a settlement option. Holding these rights in a fiduciary capacity, such as being the trustee of a trust that owns the policy on your life, can also cause the proceeds to be included in your estate.
Methods for Avoiding Incidents of Ownership
To prevent life insurance proceeds from being included in a gross estate, the insured must not hold any incidents of ownership at the time of death. The most common strategy is to have the policy owned by an Irrevocable Life Insurance Trust (ILIT). An ILIT is a legal entity created to own the life insurance policy, and because it is irrevocable, the grantor cannot change its terms or reclaim the assets.
When an ILIT is established, a trustee is appointed to manage the trust and the policy according to the trust document. The grantor makes cash gifts to the trust, and the trustee uses that money to pay the policy premiums. Since the trust is the legal owner and beneficiary of the policy, the insured holds no incidents of ownership.
A regulation to understand when transferring an existing policy is the “three-year lookback rule” under Internal Revenue Code Section 2035. If an individual transfers ownership of a policy to an ILIT and dies within three years of the transfer, the IRS will include the death benefit in the decedent’s taxable estate. To avoid this rule, it is often preferable for the trust to purchase a new policy directly.