Third-Party Policy Ownership Flashcards
Why is 3rd party ownership used?
What is formed to create this 3rd party ownership?
Third-Party Policy Ownership can be used privately to keep the death benefits ___________ .
The policyowner of the life insurance policy is usually an _______________________ (ILIT) created by the insured or an adult child of the insured.
Third-Party Policy Ownership can be used privately to keep the death benefits out of probate and the policies proceeds are not subject to estate taxes.
The policyowner of the life insurance policy is usually an irrevocable life insurance trust (ILIT) created by the insured or an adult child of the insured.
Thus, they would not be subject to federal estate taxes. However, the death benefits must not be payable to the insured’s estate for this to occur.
How is 3rd party ownership by businesses used?
Third-party ownership of life insurance policies is far more common in the business market than in the personal market.
Life insurance used to meet business insurance needs is normally owned by the business rather than the insured. A typical business use of life insurance is known as key person, or key employee life insurance.
In this scenario, the business applies for, owns, and is the beneficiary of the policy covering the life of a key employee. Upon the insured employee’s death, this benefit is intended to compensate the business for the loss of its key employee through death.
What is the Bring-Back Rule?
To avoid inclusion in the insured’s estate, it is best to set up the third-party ownership when the policy is issued.
When an existing policy is transferred to a third-party owner after it is issued, it must be three years before the insured’s death or the death benefits will be included in their estate and taxed.
(This situation is called the bring-back rule.)
Stranger or Investor-Owned Life Insurance (STOLI and IOLI)
Third-party ownership has made it possible for a questionable investment practice to have emerged: stranger-owned life insurance, or STOLI. Also known as investor-owned life insurance, or IOLI,
It is an arrangement in which an investor or investor group convinces a consumer—usually someone between the ages of 65 and 80—to take out an insurance policy on his or her life in exchange for an eventual lump-sum payment.
Since policy ownership can be changed without the need for continued insurable interest, this practice is legal in the strictest sense.
However, the STOLI investor has no interest in the continued life and well-being of the insured; in fact, the STOLI arranger benefits only by the death of the insured. For this reason, a STOLI agreement is nothing more than a wager on someone’s life.
Accordingly, it has generated considerable controversy with regulators, industry leaders, and legislators, and it is broadly discouraged in most jurisdictions.
Many states have declared such arrangements fraudulent and illegal. State law and the courts have held that STOLI arrangements run counter to public policy and have supported life insurers that have refused to pay out death proceeds from policies that were determined to be subjects of STOLI transactions.
Key Points
- There must be an insurable interest between the applicant and the proposed insured for third-party ownership to be valid when a life insurance policy is issued. However, after a policy is issued a third-party ownership arrangement can be set up (by transferring ownership to another party) without regard for insurable interest.
- A primary reason for third-party ownership of a life insurance policy in the personal insurance market is to prevent the policy’s death benefit from being included in the insured’s federal gross estate.
- Life insurance used to meet business insurance needs is normally owned by the business rather than the insured.
