There may be adverse tax consequences where the owner, insured, and beneficiary of life insurance are all different people. This situation commonly arises when you own a life insurance policy that insures the life of your spouse, and lists your child as the beneficiary of the death benefit.
One major benefit with life insurance is that the death benefit is typically income tax-free. However, when the policy owner, insured, and beneficiary are all different individuals, upon the death of the insured, the death benefit is treated as a gift from the policy owner to the beneficiary in the amount of the death benefit. When the death benefit is greater than the annual gifting exclusion (currently $15,000), it would be treated as a taxable gift requiring a gift tax return.
To further complicate the matter, if the policy owner has estate tax concerns, this gifted amount over the annual gifting exclusion will be counted toward the policy owner’s estate tax exemption for his or her estate.
When it comes to making a decision on who to pick as a beneficiary of a life insurance policy, tax consequences should be kept in mind. If you currently have a life insurance policy where this is an issue, the beneficiary of that policy should be reexamined to see if a change should be made.