Who Is the Policy Owner in Life Insurance?

Life insurance serves as a financial tool, offering protection and peace of mind by providing a death benefit to designated individuals or entities upon the insured’s passing. Understanding the different parties involved in a life insurance contract is important for managing this financial asset effectively. The policy’s structure determines who controls it and who receives its benefits.

Key Roles in a Life Insurance Policy

A life insurance policy typically involves three distinct parties: the policy owner, the insured, and the beneficiary. The policy owner is the individual or entity that holds all contractual rights and controls the policy, including the power to make decisions and pay premiums. This person or entity effectively “owns” the financial contract.

The insured is the person whose life is covered by the policy, and whose death triggers the payment of the death benefit. While the owner and the insured are often the same person, they can be different. This distinction is particularly relevant in various financial planning scenarios.

The beneficiary is the individual, group, or entity designated by the policy owner to receive the death benefit proceeds when the insured dies. Policy owners can name multiple beneficiaries and specify the percentage of the death benefit each will receive. Clearly designating beneficiaries helps avoid probate and ensures funds are distributed as intended.

Powers and Responsibilities of the Policy Owner

The policy owner possesses significant control over the life insurance contract. This control includes the ability to change the beneficiary designation, a process requiring a form submitted to the insurance company. The owner can also access the policy’s cash value, if applicable, through withdrawals or policy loans.

Withdrawals from a cash value policy are generally tax-free up to the total premiums paid. However, any amount withdrawn exceeding this amount may be taxed as ordinary income. Policy loans are typically not taxable as long as the policy remains in force. If a policy with an outstanding loan lapses or is surrendered, the loan amount can become taxable income.

The owner also has the right to assign or transfer policy ownership, choose settlement options for the death benefit, and make changes to policy terms like coverage amount or premium payment frequency. The owner is also responsible for paying premiums to keep the policy active. Failure to pay premiums can lead to the policy lapsing, resulting in a loss of coverage.

Changing Policy Ownership

Transferring the ownership of a life insurance policy is a formal process, initiated by completing a transfer form provided by the insurance company. Both the current and new owners need to sign this document, and the insurer must be notified to ensure the change is officially recorded. This transfer is irrevocable once completed.

Reasons for changing ownership vary, driven by estate planning or financial objectives. Gifting a policy can remove its value from the original owner’s taxable estate, potentially reducing estate tax liabilities. If a permanent life insurance policy is gifted, its fair market value at the time of transfer may be subject to gift tax, though exemptions often apply.

When transferring ownership, the “three-year rule” for estate tax purposes is important. If the original owner dies within three years of transferring the policy, the death benefit may still be included in their taxable estate. For high-net-worth individuals, transferring a policy to an Irrevocable Life Insurance Trust (ILIT) is a strategy to remove the policy from the taxable estate.

Common Ownership Scenarios

Life insurance policies are owned by entities other than the insured for specific purposes. An Irrevocable Life Insurance Trust (ILIT) can own a policy to exclude the death benefit from the insured’s taxable estate. The trustee of the ILIT manages the policy and receives the death benefit, which is then distributed according to the trust’s terms, providing liquidity for estate taxes or other expenses. Contributions made to an ILIT to pay premiums are considered gifts.

Businesses also utilize life insurance ownership. Key Person Insurance involves a business owning a policy on an employee, with the business as the beneficiary. The death benefit provides funds to mitigate financial losses due to the employee’s death. Premiums for key person insurance are generally not tax-deductible for the business, but the death benefit received is typically income tax-free. Businesses may also use life insurance in buy-sell agreements, where partners or shareholders own policies on each other to fund the purchase of a deceased owner’s share.

Parents or guardians own policies on their minor children. This allows for coverage at a younger age, securing lower premiums and insurability. The parent maintains control of the policy until the child reaches legal age, at which point ownership may be transferred. Spouses own policies on each other, which can offer estate tax advantages.