Who Is a Third-Party Owner in Insurance?
Understand insurance policy ownership beyond the insured and beneficiary. Learn about third-party owners, their roles, and common scenarios.
Insurance policies serve as financial tools, providing a designated payout upon specific events. While many assume the insured person also owns the policy, this is not always the case. Scenarios exist where someone other than the insured or beneficiary holds the policy’s rights and responsibilities. This arrangement, known as third-party ownership, enables flexibility in financial and estate planning.
Understanding Third-Party Ownership
A third-party owner is an individual or entity that owns an insurance policy on someone else’s life, and is neither the insured nor the beneficiary. Insurance policies typically involve three distinct roles: the insured, the policy owner, and the beneficiary. The insured is the individual whose life is covered by the policy, and whose death triggers the payout. The policy owner is the person or entity with legal control over the policy, responsible for paying premiums and making decisions about its terms. The beneficiary is the individual or entity named to receive the death benefit when the insured passes away.
A third-party owner holds significant control over the policy. This includes the ability to name or change beneficiaries, transfer policy ownership, surrender the policy for its cash value, or take out loans against the cash value. They are also responsible for ensuring premiums are paid to keep the policy in force. This separation of roles allows for strategic financial planning.
Typical Situations for Third-Party Owned Policies
Third-party ownership structures are common in various personal and business financial strategies. One frequent scenario involves businesses securing “key person” insurance on valuable employees. The business owns the policy on an executive or other individual essential to its operations, pays the premiums, and is named as the beneficiary. This arrangement provides the company with financial protection against losses that could arise from the death or incapacity of that employee, such as costs for recruiting a successor or lost revenue.
Estate planning often utilizes third-party ownership, particularly through Irrevocable Life Insurance Trusts (ILITs). An ILIT is an irrevocable trust established to own a life insurance policy, typically on the life of the person who created the trust. The primary purpose of an ILIT is to exclude the death benefit proceeds from the insured’s taxable estate, thereby reducing federal estate tax liabilities. The trust, as the owner, receives the death benefit, which can then be used to provide liquidity to the estate for expenses like taxes, without the proceeds themselves being subject to estate taxes. The “three-year rule” applies when transferring an existing policy to an ILIT: if the insured dies within three years of the transfer, the policy proceeds may still be included in their taxable estate.
Life insurance policies are also frequently gifted, creating third-party ownership. For instance, a parent might purchase a policy on an adult child, retaining ownership to ensure the policy remains active, or directly transfer ownership of an existing policy to them. Such gifting can have tax implications, as the transfer of a policy with cash value exceeding the annual gift tax exclusion limit may be considered a taxable gift. Another common instance of third-party ownership arises from divorce settlements. Courts may require one ex-spouse to maintain a life insurance policy on their life for the benefit of the other ex-spouse or children, often to secure alimony or child support payments. In these cases, the receiving spouse may become the policy owner to ensure premium payments are made and to have control over the policy.
The Parties in a Third-Party Owned Policy
The parties in a third-party owned policy have distinct roles and responsibilities. The insured is the individual whose life is covered by the policy. This person generally undergoes medical examinations and provides personal health information during the application process. While the insured’s consent is usually required for policy issuance, they do not control the policy’s terms once it is in force. Their primary responsibility is to provide accurate information to the insurer.
The policy owner, in a third-party arrangement, holds all incidents of ownership. Their rights include changing the beneficiary, surrendering the policy, accessing cash values, and assigning or transferring ownership. The owner is also responsible for paying all premiums to keep the policy active. If the owner is a trust or a business, the trustee or business entity exercises these rights and responsibilities.
The beneficiary is the individual or entity designated to receive the death benefit proceeds upon the insured’s passing. In a third-party owned policy, the beneficiary may or may not be the policy owner. For example, in key person insurance, the business is both the owner and the beneficiary. In an ILIT, the trust is the owner, and the beneficiaries are typically the trust’s heirs. The beneficiary claims the death benefit upon the insured’s death. The policy owner has the right to change the beneficiary designation at any time, unless an irrevocable beneficiary has been named.