From time to time, we are asked about the tax consequences of transferring life insurance policies particularly in the context of some common (or not-so common) estate and trust planning scenarios involving transfers.
As most people know, when a transfer of ownership of a life insurance policy occurs, the transferor reports a taxable gain, which is essentially the proceeds of disposal less the transferor’s’ adjusted cost basis (ACB) in the policy. However, if the proceeds of disposal are less than the ACB, the resulting loss is not recognized for tax purposes.
Some types of transfers can be achieved without tax consequences and be of assistance with estate plans.
When a transfer is made between spouses or common law partners, there is an automatic rollover, unless they elect to opt out. So an individual can transfer a life insurance policy to a spouse or common law partner and deem to receive proceeds of disposition equal to the ACB, the receiving spouse is deemed to pay an equal amount. These tax-deferred transfers between spouses or partners may occur while both are alive, or between a deceased’s estate and the survivor.
Parents who purchase a policy on a young child can transfer ownership to that child when he or she is an adult on a tax-deferred basis.
Grandparents can also purchase a policy of on the life of their grandchild and later transfer that policy to the grandchild’s parents. This can help ensure control of the policy remains with an adult until the grandchild is old enough to take ownership of the policy.
The main caution with these transfers is that the transferor has to be alive because a tax deferred rollover cannot be effected from the grandparent’s or parent’s estate. However, naming the child as the contingent owner of the policy will allow him or her to receive it on the death of the older generation.
A policy can be owned by a trust, which can then transfer it to a capital beneficiary on a tax-deferred basis. The beneficiary would assume the trust’s ACB in the policy for tax purposes.
Transfers can be effected on a tax deferred basis when a policy owned by a corporation that’s being amalgamated or wound up with or into another corporation. In an amalgamation, the new corporation is considered to be a continuation of the merged companies and the policy is transferred at its’ ACB. In a windup, the parent corporation assumes the policy at the wound up corporation ACB.
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