Transferring Life Insurance Policies For PepsiCo Employees

One interesting aspect to consider for 60-year-olds looking to retire is the option of transferring their life insurance policies. According to a recent study by LIMRA, the life insurance industry research group, 50% of retirees who own a life insurance policy consider transferring their coverage to a loved one or a trust, as it can provide financial benefits for both the policyholder and their beneficiaries. This can be a great way to ensure that their legacy is preserved and their loved ones are taken care of financially. (Source: LIMRA, 'Retirees, Life Insurance and the Benefits of Policy Ownership Transfer,' March 2022)

What Is It?

As the proprietor of a life insurance policy, you are entitled to a variety of rights and privileges. These include the right to name and change your beneficiary designation, the right to select and change settlement options, the right to borrow against or withdraw from the policy, and the right to receive dividends paid by the insurance company. One of the most essential rights you have as a policyholder is the right to transfer ownership. This right provides flexibility to your life insurance contract that it would not have otherwise and that other forms of assets lack.

You are most likely both the designated insured and the sole owner of your life insurance policy. In some instances, however, the named insured has no or only a portion of the policy's ownership rights. Obviously, this implies that the insured is either a non-owner or a partial owner of the policy. Numerous insurance policies are purchased and held by parties other than the insured. Policy transfers may result in additional exceptions to the general norm that the insured and policyholder are one and the same.

A transfer is the assignment of ownership interest in a life insurance policy to another individual, institution, or entity such as a trust through sale or donation. If you transfer or sell all of your policy's ownership rights to a new proprietor, you have completed a total transfer of ownership, also known as an absolute assignment. You can also grant or sell less than all of the ownership rights, in which case you would continue to be a partial owner of the policy. In the same way that there are times when it is appropriate to replace your existing policy, alter your level of coverage, or leave the policy as is, there may be times when a full or partial transfer of your policy is warranted.

Tip:  This discussion assumes that the original owner in a policy transfer is the person whose life is insured by the policy and that ownership interest passes from this insured owner to a noninsured owner. Be aware, however, that many policy transfers involve transferring interest from a noninsured owner to another party. Such transfers may not involve the insured party at all (i.e., the insured may be neither transferor nor transferee).

Caution:  Since the rules dealing with ownership rights vary from one policy to the next, you should carefully read the appropriate clauses in your policy if you are considering a transfer. The assignment clause, in particular, should give you most of the information you need. Many insurance companies reserve the right to refuse to guarantee the validity of any policy transfer or assignment.

Caution:  If you transfer an interest in your policy to another party in exchange for valuable consideration, the death benefits payable under the policy will generally be included in the beneficiary's income when received by the beneficiary to the extent that such benefits exceed the amount the purchaser paid for the policy and any premiums paid by the purchaser. In addition, a transfer may involve other tax issues. You should consult a tax planning professional before you proceed.

When Might It Be Appropriate to Transfer Your Policy?

You Need Collateral for a Loan

This is the most prevalent situation where transfers are utilized. Suppose you wish to borrow money from a bank or other financial institution but lack the traditional forms of collateral (e.g., real estate or investment assets) required to secure such a loan (e.g., real estate, investment assets). You may believe you are completely out of luck. However, if you own a life insurance policy, you may be able to use a portion or all of your ownership interest as collateral to secure the loan. In fact, the bank or company from which you wish to borrow may stipulate this as a condition of the loan.

This is known as a collateral assignment and entails transferring some or all of the ownership rights to your policy to the lending institution. It functions as follows. If you (as proprietor and insured) pledge your policy as collateral for a loan and then die before the loan is repaid in full, your lender would be entitled to a portion of the policy's death benefits equal to the outstanding balance of your loan at the time of your death. The remaining death benefits, if any, would then be paid to the beneficiary(s) you designated in the policy.

Example(s):  Say you own a life insurance policy that will trigger $100,000 in death benefits at your death. You borrow $50,000 from your local bank for home improvements and pledge your interest in the policy as collateral. If you die five years later having paid off only $25,000 of the loan, the bank will be entitled to collect the remaining $25,000 owed to them (plus any interest) from the life insurance death benefits paid by your insurance company. The remaining $75,000 in death benefits (adjusted for interest) would be payable to your beneficiary(ies).

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Example(s):  In another scenario, say you have the same life policy with $100,000 in death benefits but that you borrow $150,000 from your bank instead of $50,000. If you die having paid off only $25,000, the $100,000 in death benefits triggered by your policy would not be enough to pay off the $125,000 outstanding balance (plus any interest) of your bank loan. Thus, the bank would be able to collect the full amount of your life insurance death benefits, leaving your beneficiary(ies) with nothing. The bank would also be able to seize additional assets of sufficient value to cover the balance of the loan. However, if you die having paid off your loan in full, the bank would not be entitled to receive any of your death benefits, all of which would go to your beneficiary(ies).

As demonstrated by these examples, the amount of death benefits that your lender can collect in the event of a collateral assignment depends on the outstanding balance of your loan at the time of your death. It is limited to the quantity specified in your policy's death benefit coverage.

Tip:  If you need money, it may be more advantageous to borrow against the policy rather than pledging it as collateral for a bank loan. A policy loan may provide you with a more favorable interest rate than a bank loan. However, you should check your policy's loan provision section to make sure you are allowed to borrow against it. Also, since the amount you can borrow will generally be limited by the policy's cash value, make sure your cash value is sufficient to cover the amount of the loan you want. And remember, if you die before the loan has been paid off, the death benefit will be reduced by the amount of the loan still outstanding.

Caution:  If you are planning on transferring policy ownership rights to a bank via a collateral assignment, check to see what type of assignment form your bank intends to use. The assignment form most used and most favorable to borrowers is the ABA assignment form. This form, developed by the American Bankers Association in cooperation with representatives of the life insurance industry, provides for the transfer of just enough policy ownership rights to protect your lender from financial loss. If your bank plans to use its own prepared assignment form, which may entitle them to receive more ownership rights than they need, request the ABA form with its more favorable borrowing terms.

A Transfer Seems Advantageous for Income Tax Reasons

Generally, the cash value accumulation in a life insurance policy is exempt from federal income tax if the policy terminates due to a mortality claim. Any cash value gain on the policy, however, will be subject to income tax if the policy is surrendered for cash. If you need to access the cash value of the policy for whatever reason, a transfer could be a viable option that allows you to avoid a hefty income tax burden while still obtaining the necessary funds.

Consider that you want to surrender your policy so that you can pay for your grandson's college education with the proceeds. If your grandson is in a lower income tax bracket than you, it may be prudent to designate the policy to him so he can make the withdrawal himself. You could make alternative arrangements to reimburse your grandson for the resulting tax liability, but the net result would be a lower total income tax liability on the same withdrawal that would have cost you more in taxes otherwise. You ultimately pay the federal government less money out of pocket.

Caution:  In the case of a straight assignment like the one described above, there may be federal gift and estate tax consequences that could potentially reduce or even exceed the income tax benefit of the transfer. If so, it may make more sense from a tax standpoint to borrow against the policy rather than surrender all or part of its cash value. For you to exercise this option, your policy must have a loan provision that allows you to borrow against it as well as sufficient cash value to cover the loan.

Tip:  Another possible income tax consideration with life insurance concerns the issue of  dividends,  if any. In general, if you receive dividends on your policy that do not exceed your cost basis (i.e., the amount of your investment) in the policy, those dividends will not be included in your income. However, if the dividends received do exceed your cost basis, they may be subject to income tax. If so, it may be to your advantage for income tax purposes to structure an assignment of the policy to someone in a lower income tax bracket, rather than receiving the dividends yourself, and then making a gift of those dividends to the same person. However, as noted above, the assignment of the policy may have federal gift and estate tax implications.

A Transfer May Be Advantageous for Estate Tax Reasons

If you own a life insurance policy and die with the policy still in your name, the death benefits are generally exempt from federal income tax but not from federal gift and estate tax. In such a circumstance, the proceeds payable to your beneficiaries are included in your estate and subject to taxation. Unless the total value of your estate (including the proceeds of life insurance policies you owned at the time of your death) exceeds the applicable exclusion amount for the year of death, no tax is owed. Because the proceeds may be subject to estate tax, your beneficiary(s) may ultimately receive less money. The proceeds are included in your estate because, as the policy owner, you had an incident of ownership in the policy.

Therefore, if you transfer ownership of the policy to another person or entity, you can minimize the tax that would otherwise apply to the death benefits of your life insurance policy. Here, a transfer or assignment of ownership rights could be relevant. In order to shield life insurance death benefits from federal gift and estate tax, it is common for policyowners to establish a trust and transfer ownership of the life insurance policy to the trust. If correctly executed, this method can ensure that the proceeds of your life insurance policy are paid to your beneficiaries tax-free upon your death.

Caution:  Keep in mind that if you die within three years after transferring ownership of your life insurance policy, the death benefits payable under the policy may still be included in your estate for federal gift and estate tax purposes (according to Internal Revenue Code Section 2035). The IRS reasons that if you had any interest in the policy within the last three years before your death, any proceeds from it belong in your gross estate. While it's obviously impossible to know when you will die, you may want to take appropriate estate planning steps, including a well-timed policy transfer, based on your age, health, and other factors.

Tip:  Life insurance death benefits payable solely to your surviving spouse may be eligible for what is known as the federal unlimited marital deduction. If this applies to you, you may not need to effect a policy transfer to avoid tax on policy proceeds. Bear in mind, however, that there may be no such  unlimited marital deduction  if death benefit payments can continue beyond your surviving spouse's death. When your surviving spouse dies, any remaining unpaid death benefits payable by reason of death would generally be includable in your surviving spouse's estate and become subject to gift and estate tax.

A Transfer May Be Advantageous for Tax Deductibility Reasons

This is possible if you transfer your life insurance policy to a charity or a charitable remainder unitrust. In addition to the positive emotions you may experience from such a charitable act, this type of transfer can provide you with substantial tax advantages. You may be eligible for one or more of the following if you relinquish all incidents of ownership (as defined by the IRS) in the policy: (1) an income tax charitable deduction, (2) a gift tax charitable deduction, and (3) an estate tax charitable deduction. However, these deductions may not apply if you retain any incidents of ownership or receive any economic benefit from the policy after the transfer.

Tip:  If you transfer your life insurance policy to a charity or a charitable remainder trust and then continue paying premiums toward the policy even though you no longer own it, those premium payments may also be tax deductible up to a certain amount.

Caution:  Despite the obvious tax advantages of transferring your life insurance policy to a charity or a charitable remainder trust, Internal Revenue Code Section 2035 may apply and draw the death benefits payable under the policy back into your estate if you die within three years of the transfer. If the proceeds are includable in your estate through application of Section 2035, they may be subject to federal gift and estate tax. Keep in mind, however, that any applicable charitable deduction may offset or at least soften the tax consequences.

Caution:  A transfer of your policy may bring into play additional tax issues. For example, the transfer of a policy to an employee as compensation for services performed may have its own special tax considerations. For more information on this and other tax issues, you should definitely consult additional resources.

You Simply Need the Money

This only applies to sales-based policy transfers. If you need money urgently and severely, you may be able to sell your life insurance policy to another party for cash or other consideration.

Caution:  Keep in mind that the transfer-for-value rule may apply to the sale of your policy for cash or other forms of valuable consideration. If so, all or a portion of the death benefits payable under the policy may lose their status as income tax exempt. With this in mind, you may want to consider a transfer by sale only if you have no other means of raising the money you need.

Conclusion

Retirement planning is like building a house. Just as a house needs a solid foundation to ensure its long-term durability, retirees need a solid financial foundation to ensure their long-term financial security. This article provides valuable insights and guidance to help PepsiCo workers looking to retire, as well as existing retirees, build a solid financial foundation that can support them throughout their retirement years. From setting realistic goals and creating a budget to making smart investment choices and seeking professional advice, this article offers a comprehensive roadmap for building a strong financial foundation and enjoying a fulfilling retirement.