205 / Can an insured give a primary beneficiary limited, noncumulative withdrawal rights without causing any remaining unpaid life insurance proceeds to be includable in the primary beneficiary's estate?

If the insured gives a primary beneficiary (e.g., a spouse) a “qualifying income interest for life” in the proceeds, the proceeds will be includable in the primary beneficiary’s estate if the marital deduction election was made, regardless of whether the primary beneficiary has a power to withdraw any of the proceeds ( Q 193).¹ If the primary beneficiary does not have such an interest in the proceeds, the insured can give a beneficiary a noncumulative right to withdraw each year up to $5,000 or 5 percent of the balance of the proceeds, whichever is greater. If the beneficiary’s annual withdrawal right does not exceed these limits, the amounts the primary beneficiary could have withdrawn but did not withdraw are not includable in the primary beneficiary’s gross estate (except the unwithdrawn amount that the primary beneficiary could have withdrawn in the year of his or her death).²

Example. The proceeds of a $100,000 life insurance policy are left with the insurer under the interest-only option for the insured’s daughter. The daughter is given a noncumulative right to withdraw $5,000 a year. She does not have a power to appoint the proceeds to her estate. The daughter dies seven years later, having withdrawn none of the proceeds. Only $5,000, the amount she could have withdrawn in the year of death, is includable in her gross estate.³

If the beneficiary’s noncumulative withdrawal right exceeds the $5,000/5 percent limits, the aggregate withdrawable amounts in excess of these limits that the beneficiary did not withdraw will be includable in the beneficiary’s gross estate (but not in excess of the full proceeds). Thus, if the daughter in the example above had a power to withdraw $6,000 annually, and she did not withdraw the excess amount, then the amount includable in her gross estate would be $12,000 [6 × $1,000 (amount in excess of $5,000 for six years) + $6,000 (year of death)].