Situation: A married couple are getting divorced. They jointly own, as a revocable living trust, a whole life insurance policy covering the husbands life. As part of the divorce settlement the husband has offered to surrender the insurance policy and transfer the cash value to the wife.Questions: Will the IRS allow the policy to be surrendered and cash value transfered as part of the divorce decree without recognizing gain? (ref: IRC Section 1041) If not, who is responsible for paying the taxes due on cash value in excess of cost basis?
Greetings,
Indeed, transfers incident to divorce can be made without any tax consequence.
However, distributions from tax deferred vehicles will be subject to tax even when used to settle the marital assets.
That is, when a spouse transfers a tax deferred account there is not tax consequence; but there may be income tax on distributions from the account. This is true for retirement accounts and insurance accounts.
Basically, transferring ownership of the policy is not subject to tax under section 1041; but gain on cashing in the policy is not excluded from tax under section 1041.
This may not be important if the premiums paid are more than the cash value accrued so that there is no gain realized on surrender of the policy.
The owner of the policy at the time of surrender will be responsible for any income tax on the gain.
Transferring ownership of the policy rather than transferring the proceeds from surrender is very likely more tax advantaged in almost all circumstances; but, as always, only a practitioner that has all of the facts and circumstances can make an informed opinion for their client, the taxpayer.
Please ask if you need clarification.
Thank you.
Is it possible for the wife to own a life insurance policy on their ex-husband since there is no longer any financial dependance on the husband?
Hello again,
Although my life insurance license has been expired for a few years now and I am not an attorney, it does seem proper for an ex-spouse to own a policy on the other ex-spouse and does happen (at least in my state).
There are obvious circumstances, such as receipt of alimony or support that would be a direct economic interest and thereby provide the insurable interest.
The precise answer will lie in the specifics of state law on insurable interest when there is not a direct economic interest. It may even depend if the transfer is done prior to the dissolution as most states do allow an ex-spouse to continue to own a policy that was purchased and owned during the marriage.
I hope this helps to clarify even though that aspect is a matter of state law whic a local attorney will need to confirm.