180 / When are death proceeds includable in the estate of a life income beneficiary of a life insurance trust?

If a life income beneficiary is the owner of insurance policies payable to a life insurance trust at the time of the insured’s death and the life income beneficiary is still the beneficiary at the time of death, an amount equal to the death proceeds will be includable in the life beneficiary’s estate under IRC Section 2036(a)(1) as a transfer of the proceeds with a life income interest retained.¹

In one case, an insured husband created a nonfunded revocable life insurance trust under which his wife was the life income beneficiary and the wife paid premiums out of her own funds. The court held that on the death of the wife, who died after the husband, the premium payments were not considered transfers, and the proceeds therefore were not includable in her estate under IRC Section 2036(a)(1).² However, when a trust is irrevocable, there is a possibility that payment of premiums by the income beneficiary may cause the income beneficiary to be considered a co-grantor of the trust. Thus, the income beneficiary may be considered to have made a transfer with a retained income interest. This would cause the portion of the proceeds attributable to such premiums to be includable in the income beneficiary’s estate upon the income beneficiary’s subsequent death.³ Trust beneficiaries would not hold incidents of ownership in life insurance under IRC Section 2042 where (1) a beneficiary could not make contributions to a trust that might hold life insurance on the beneficiary’s life and (2) a beneficiary’s limited power of appointment could not be exercised if the trust held life insurance on the beneficiary’s life.⁴

1. Rev. Rul. 81-166, 1981-1 CB 477.