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Policy Ownership: Where should ownershi p be ? What is involved in changing ownership ?
February 4, 2020 | Posted by: Jatinderbir Singh BajwaHello all! Happy New Year to you.
I trust everyone got some time for rest and relaxation with friends and family over the break. Now we are all back with noses to the grindstone for, hopefully, a very productive year.
One particularly common subject we at ACES run into is where should the ownership of a policy be and what is involved in changing ownership if we come across a policy that is not ideally situated.
Let us first look at a policy issued on an individual for personal use, i.e. mortgage protection or to create income in the event the insured suffers a premature death. These are the most common situations and have the most common answers. If we have an individual insured for any number of personal reasons, then the easiest and best solution, in my opinion, is to have the insured, spouse, parent or grandparent own the policy. Also, the individual owner would typically be the payor of the premium.
Just a couple of quick side notes. First, if the policy is a joint policy of any variety you should have joint ownership or at least a contingent owner. Second, you cannot move a personally held policy to any other individual on a tax-free basis. The one exception is if the insured is the child or grandchild of the current owner, then a tax-free roll-over to the child or grandchild is available.
If the policy is transferred to a non-arm’s length individual, the proceeds of disposition are deemed to be the greater of the CSV, ACB, or FMV (consideration paid). If either the CSV or FMV exceeds the ACB, there is a taxable policy gain to the individual. The new owner receives the policy with an adjusted ACB equal to the proceeds of disposition.
The next scenario surrounding change of ownership involves an individual and a corporation. If an individual wants to transfer ownership to his or her company, the transfer occurs at the greater of one of three values (ACB, CSV, FMV). First, the policy must have its FMV calculated by a qualified actuary. This will form the new transfer price of the policy. If the proceeds of disposition (Transfer Price) exceed the ACB, then a policy gain is realized and attributed back to the original owner. If consideration is paid for the policy, and this consideration exceeds the FMV, then the owner/shareholder may be liable for a taxable shareholder benefit. I would make another side note here, that many business owners prefer to have their companies pay for their life insurance because premium dollars are earned at a much lower, generally speaking, marginal tax rate than for the individual. So again, the individual must weigh the cost of a potential tax liability created on transfer against the benefit of paying insurance premiums with lower MTR dollars. In addition, the ACB of the policy to the corporation will be the transfer price calculated above, which normally means an increase in the ACB. This now has implications for the payout of the death benefit. As we are aware, the ACB of the policy is paid out as a taxable dividend on the death of the insured to the beneficiaries and any surplus of the death proceeds, in excess of the ACB, are paid out as a tax-free Capital Dividend. This means that if death occurs in the early years of a transfer, there still may be significant ACB in the policy, which will reduce the total amount of tax-free cash available to the beneficiaries.
Now if we consider the reverse transaction, where the ownership is transferred from the corporation to the owner/shareholder, the transfer price is deemed to be the greater of ACB, CSV or FMV. If either the CSV or FMV exceed the ACB, a policy gain will accrue to the corporation. The policy can then be transferred straight to the owner/shareholder at its FMV and the owner/shareholder will have to claim a taxable shareholder’s gain in the same amount. The policy could be transferred in a more tax effective manner, as a “dividend in kind”, for no consideration. The owner/shareholder must treat the “dividend in kind” as a taxable dividend, and thus tax considerations arise.
As you can see, there are many potential variations on how a policy is transferred and as many or more ways in which the value of the transfer can be calculated or paid for. The purpose of this part of the discussion is just to let you know that change of ownership can be very complicated and must be done with a good deal of caution.