The Importance of Policy Review
The death benefit of Life Insurance is paid out tax free normally if the owner and beneficiary are structured properly. You would assume that an Attorney or CPA client would have the policy structured properly. That is not always the case.
I reviewed a group of policy’s that were part of a Split Dollar Plan for a group of partners in a CPA plan. There were six policies that the CPA firm was paying the premium. The two oldest policy’s were in what is called a Reverse Split Dollar Plan. That type of Split Dollar Plan was no longer allowed by the IRS when they updated the rules in 2001. The other four policies were in a favorable Split Dolar Plan, but they CPA firm had not done the correct accounting of the premiums paid that is required. Al six policy’s had the company as owner and payor with Partner or insured naming a beneficiary. This caused the death benefit to be considered a gift, because the insured, owner and beneficiary are three different parties. This is called the Goodman Rule.
The Goodman Rule is a 1946 US court case, Goodman v. Commissioner of Internal Revenue. Mrs. Goodman transferred several life insurance policies she owned on her husband to a Revocable Trust in 1930. The trust became irrevocable after Mr. Goodman passed away in 1946. Mrs. Goodman as the owner then donor failed to give up control of the trust and was responsible for making a “taxable gift.” The policy had been structured with Mr. Goodman as the insured, Mrs. Goodman as the owner and donor to the trust, and the beneficiaries were her three children and sister in-law. Because Mrs. Goodman retained some control of the trust the death benefit was considered an “incomplete gift”. The gift tax would have been avoided had Mrs. Goodman relinquished control of the trust.
You can avoid the Unholy Trinity by being cognizant of the three title structure points of a life insurance policy. The insured, owner, and beneficiary. Two of these structure points should be the same person or entity. When all three are different you likely have the Unholy Trinity. In the Goodman Case Mr. Goodman was the insured, Mrs. Goodman the owner and donor, and her children and sister in-law the beneficiaries.
Businesses taking out life insurance on owners and employees is a scenario where the policy falls victim to the Unholy Trinity. The business owns and pays for the policy on an employee who is the insured and the employee names their spouse as the beneficiary. The problem is that there is three different people or entities on each different structure point. An employer wanting to offer a benefit to an employee unknowingly creates a tax problem in the future. Executive bonus or split dollar arrangements can prevent that from happening.
The lesson of this story is don’t assume your CPA and or Attorney clients will have their policy’s structured correctly. This firm had an out of favor Split Dollar Plan and the wrong structure. I was able to help the advisor bring awareness to their client.
LPL Tracking Number: #734127-6
Securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through WCG Wealth Advisors, a registered investment advisor. WCG Wealth Advisors and The Wealth Consulting Group are separate entities from LPL Financial.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.
