What Are Incidents of Ownership?

A person (including a trustee) has incidents of ownership if they have the right to change beneficiaries on a life insurance policy, to borrow from the cash value, or to change or modify the policy in any manner. This occurs even if the person chooses not to act on it and even if they don't borrow from the policy. Simply the ability to do so gives the insured incidents of ownership.

Key Takeaways

  • Incidents of ownership is a reference to the rights of a person or trustee to change the beneficiaries on a life insurance policy, to borrow from the cash component, or to alter the policy in some way.
  • The question of incidents of ownership comes up in terms of tax responsibility when a person gifts a life insurance policy to another person or entity.
  • When such a transference is made, the person making the gift must give up all legal rights to the policy and not pay any premiums.
  • Different kinds of life insurance policies have specific requirements regarding incidents of ownership.

Understanding Incidents of Ownership

At times, the Internal Revenue Service (IRS) will look for any incidents of ownership by a person who gifts a life insurance policy to another person or entity. When transferring a policy, the original owner must forfeit all legal rights and must not pay the premiums to keep the policy in force.

Also, upon completion of the transfer, if the insured or transferor dies within three years of the date from which the policy was transferred, the life insurance proceeds will be included in the gross value of the original owner's estate (called the three-year rule).

Incidents of Ownership and a Primer on Life Insurance Policies

Stepping back, life insurance policies are numerous and all have a range of special features, such as incidents of ownership. Major types of life insurance policies include whole life, term life, universal life, and variable universal life (VUL) policies.

Whole life, one of the most common types of life insurance, guarantees coverage for the entire life of the insured and includes a death benefit and savings component where cash value may accumulate. Term life only guarantees payment of a death benefit during a specified term. A policyholder may have several options when the term expires, including renewing for another term, converting to permanent coverage, or letting the policy to terminate completely.

Universal life is a type of permanent life insurance that adds an investment savings element plus low premiums.

Finally, variable universal life (VUL) has a built-in savings component that allows for the investment of the cash value into sub-accounts. Similar to mutual funds, these sub-accounts allow plan participants to select options with varying market and risk exposure. While VULs can generate significant returns, as with any investment, can also result in substantial losses.

Incidents of Ownership and Gift Taxes 

Gift tax regulations can be complex and change regularly. It is always best to check with your respective tax authorities if you have given anyone a gift, including a life insurance policy valued at more than $15,000 on or after January 1, 2018.