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Financial Planning > Trusts and Estates > Trust Planning

Additional Issues to Consider

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Of course, any time you use qualified plan assets, such as a life insurance policy, with a subsequent sale, there are a number of tax, ERISA and legal issues to consider. One of these is the transfer-for-value rule. The sale of the contract can violate the transfer-for-value rule, thus causing a portion or all of the policys death proceeds to be income taxable.

One way to avoid this is to have the language in the irrevocable trust written so as to make it a grantor or “defective” trust for income tax purposes. This avoids the transfer-for-value rule since the trust is considered to be the same as the grantor.

Swanson v. Comm., 518 F.2d 59 (8th Cir., 1955) is generally cited for the principle that the grantor is the owner of the trust assets and that transfer of the policy to the trust is within the exception.

In addition, by having the irrevocable trust purchase the policy directly from the PSP rather than having it first transferred to the insured and then gifted to the trust, the client can avoid income and gift taxes on the transfers. The client also avoids the “three year in contemplation of death” rule that forces the policy proceeds back into the insureds estate if he or she were to die within three years of gifting the policy. This rule typically applies to a gift transaction, not a bona fide sale.

–John Oliver

Reproduced from National Underwriter Edition, May 5, 2003. Copyright 2003 by The National Underwriter Company in the serial publication. All rights reserved. Copyright in this article as an independent work may be held by the author.