Which statement regarding third-party ownership of a life insurance policy is true?
A. Beneficiary is required to be irrevocable
B. Policy cannot be assigned once issued
C. It is illegal in most states
D. It is used extensively in estate-planning as well as business circumstances
The Correct Answer and Explanation is:
The correct answer is D. It is used extensively in estate-planning as well as business circumstances.
Explanation:
Third-party ownership of a life insurance policy occurs when someone other than the insured individual purchases a life insurance policy and is responsible for paying the premiums. The third party can be anyone: an individual, a business, or an organization. This type of arrangement is common in various situations, particularly in estate planning and business planning.
Estate Planning:
In estate planning, life insurance policies are often used to provide liquidity to pay estate taxes, outstanding debts, and other expenses after an individual’s death. For example, a person might set up an irrevocable life insurance trust (ILIT), with a trustee as the third-party owner of the policy. This helps avoid having the life insurance payout counted as part of the insured’s taxable estate, reducing estate taxes. The trust can manage the policy and distribute the death benefit according to the terms set by the policyholder.
Business Planning:
Third-party ownership is also common in business arrangements. One such example is key person insurance, where a business purchases a life insurance policy on a key employee or owner. The business is the beneficiary of the policy, and the death benefit can be used to cover the financial loss or to fund a buy-sell agreement. This ensures the business is not financially crippled by the death of a key person.
Why Other Options Are Incorrect:
- A. Beneficiary is required to be irrevocable: The beneficiary designation is not necessarily irrevocable in third-party ownership. A policy owner can generally change the beneficiary unless the beneficiary designation is specifically marked as irrevocable.
- B. Policy cannot be assigned once issued: This is incorrect. Life insurance policies can usually be assigned to a third party after issuance. The assignment of a life insurance policy refers to transferring the ownership or beneficiary rights to another party.
- C. It is illegal in most states: Third-party ownership is legal in most states, especially in the context of business arrangements or estate planning. There are some restrictions on life insurance policies, but third-party ownership itself is not generally prohibited.
Thus, third-party ownership is widely used in both estate planning and business contexts to achieve financial and tax planning goals.