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Settlement options-beneficiary's estate.

677. If the insured elects a settlement option for his primary beneficiary, and names contingent beneficiaries, will the value of any unpaid life insurance proceeds be includable in the primary beneficiary's estate?

As a general rule, the proceeds are not includable in the primary beneficiary's estate unless she has a general power of appointment over the proceeds (see Q 666, Q 678) or unless she was the insured's surviving spouse and has a "qualifying income interest for life" in proceeds as to which the marital deduction was allowed (see Q 665). (2) The transfer to contingent beneficiaries is from the insured, not from the primary beneficiary. (But for a limited, noncumulative power to withdraw, see Q 681.) With respect to community property insurance, however, one-half of the proceeds belongs to the noninsured spouse. Consequently, where she is primary beneficiary, one-half of the proceeds will be includable in the insured spouse's estate, and one-half of the value of the proceeds remaining at her death will be includable in her estate. (3)

678. If the surviving income beneficiary dies possessing the power during her lifetime to appoint the life insurance proceeds only to her children, are the proceeds includable in her estate?

If the surviving spouse has a "qualifying income interest for life" in the proceeds, the proceeds will be includable in her estate if the marital deduction election was made whether or not she has any power to appoint the proceeds. (See Q 665.) (4) If she does not have a "qualifying income interest for life" in the proceeds, according to a 1979 revenue ruling, the answer depends on whether the income beneficiary at her death could have discharged her legal duty to support her children, in whole or in part, by exercising her power to appoint the proceeds. To the extent she could have, her power would be treated as a general power of appointment and the proceeds would be includable. Under the facts of the ruling, it was held that no part of the proceeds was includable because all of the income beneficiary's children were adults at the time of her death and she was not obligated under local law to provide for their support. (5) See Q 658 regarding the reciprocal trust doctrine.

679. If life insurance proceeds remaining unpaid at the primary beneficiary's death are payable to her estate, are they includable in her gross estate?

Yes. Since the beneficiary can dispose of the remaining proceeds as she wishes through her will, she is deemed to have a general power of appointment over the proceeds (see Q 666). (6)

680. If the insured elects a settlement option, naming contingent beneficiaries, but giving the primary beneficiary power to withdraw the proceeds, are life insurance proceeds remaining unpaid at the primary beneficiary's death includable in her estate?

If the primary beneficiary has a "qualifying income interest for life" in the proceeds, the proceeds will be includable in her estate if the marital deduction election was made whether or not she has a power to withdraw any of the proceeds (see Q 665). (1) Otherwise, a full power of withdrawal constitutes a general power of appointment (see Q 666). (2) Whether the possession of such a power by the primary beneficiary will cause the remaining proceeds to be taxable in her estate depends upon when the power was created. If the primary beneficiary has an unrestricted power to withdraw the proceeds, and the power was created after October 21, 1942, the value of any proceeds remaining unpaid at her death will be included in her gross estate. (3) (But for a limited, noncumulative withdrawal right, see Q 681.) If the primary beneficiary's power of withdrawal was created before October 22, 1942, the value of the unpaid proceeds is not includable in her gross estate merely because she possessed the power. (4) A power of appointment is created when the insured executes the supplementary contract electing the settlement option. This is the date the power is created even though insured retains the right to surrender the policy and to change the beneficiary. (5)

681. Can an insured give his primary beneficiary limited, noncumulative withdrawal rights without causing remaining unpaid life insurance proceeds to be includable in her estate?

If the insured gives his primary beneficiary (spouse) a "qualifying income interest for life" in the proceeds, the proceeds will be includable in her estate if the marital deduction election was made whether or not she has a power to withdraw any of the proceeds (see Q 665). (6) If she does not have such an interest in the proceeds, the insured can give his beneficiary a noncumulative right to withdraw each year up to $5,000 or 5% of the balance of the proceeds, whichever is greater. If the beneficiary's annual withdrawal right does not exceed these limits, the amounts she could have withdrawn but did not withdraw are not includable in her gross estate (except the unwithdrawn amount which she could have withdrawn in the year of her death). (7)

Example. The proceeds of a $100,000 life insurance policy are left with the insurer under the interest only option for insured's daughter. The daughter is given a noncumulative right to withdraw $5,000 a year. She does not have a power to appoint the proceeds to her estate. The daughter dies seven years later, having withdrawn none of the proceeds. Only $5,000, the amount she could have withdrawn in the year of death, is includable in her gross estate. (8)

If the beneficiary's noncumulative withdrawal right exceeds the $5,000/5% limits, the aggregate withdrawable amounts in excess of these limits which she did not withdraw will be includable in her gross estate (but not in excess of the full proceeds). Thus, if the daughter in the example above had been given a power to withdraw $6,000 annually, the amount includable in her gross estate would be $12,000 [6 X $1,000 (amount in excess of $5,000) + $6,000 (year of death)].

682. If, under a settlement option, the primary beneficiary is given the power to revoke contingent beneficiaries and appoint to her estate, are life insurance proceeds remaining unpaid at her death includable in her estate?

A beneficiary who has power to appoint to her estate has a general power of appointment over the proceeds. (1) Generally, such a power, given to a wife-beneficiary, will qualify the proceeds for the marital deduction in insured's estate (see Q 665), but will cause remaining unpaid proceeds to be includable in the beneficiary's estate. However, includability in the beneficiary's estate will depend upon when the power was created. If the power was created after October 21, 1942, the proceeds remaining unpaid at the primary beneficiary's death are includable in her estate. (2) If the power was created before October 22, 1942, the proceeds remaining unpaid at beneficiary's death are includable in her estate only if she exercised the power. (See Q 680 with respect to when a power is created.)

683. If the beneficiary elects the settlement option, are life insurance proceeds remaining unpaid at her death includable in her estate?

Yes. Thus, if the proceeds are payable to her in a lump sum and, after insured's death, she elects a settlement option for herself as primary beneficiary, the proceeds are includable in her estate. (3) Likewise, if the beneficiary as policyowner elects a settlement for herself and contingent beneficiaries, the remaining proceeds are includable in her gross estate. (4)

(2.) IRC Secs. 2041, 2044.

(3.) IRC Sec. 2036. Whiteley v. U.S., 214 F. Supp. 489 (W.D. Wash. 1963). See Tyre v. Aetna Life Ins. Co., 353 P. 2d 725 (Cal. 1960).

(4.) IRC Sec. 2044.

(5.) Rev. Rul. 79-154, 1979-1 CB 301.

(6.) IRC Sec. 2041(a); Rev. Rul. 55-277, 1955-1 CB 456; Keeter v. U.S., 29 AFTR 2d 72-1540 (5th Cir. 1972). Contra, Second Natl Bank of Danville, Ill. v. Dallman, 209 F.2d 321 (7th Cir. 1954).

(1.) IRC Sec. 2044.

(2.) Treas. Reg. [section] 20.2056(b)-6(e)(4).

(3.) IRC Sec. 2041(a)(2).

(4.) IRC Sec. 2041(a)(1).

(5.) Treas. Reg. [section] 20.2041-1; Rev. Rul. 61-129, 1961-2 CB 150.

(6.) IRC Sec. 2044.

(7.) IRC Sec. 2041(b)(2).

(8.) Rev. Rul. 79-373, 1979-2 CB 331.

(1.) Treas. Reg. [section] 20.2056(b)-6(e)(4).

(2.) IRC Sec. 2041(a)(2).

(3.) IRC Sec. 2036; Est. of Tuohy v. Comm, 14 TC 245 (1950); Est. of Morton v. Comm, 12 TC 380 (1949); Rundle v. Welch, 184 F. Supp. 777 (S.D. Ohio 1960); Let. Rul. 8051019.

(4.) Est. of Pyle v. Comm., 313 F.2d 328 (3rd Cir. 1963).
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Title Annotation:PART II: FEDERAL ESTATE TAX ON INSURANCE AND EMPLOYEE BENEFITS
Publication:Tax Facts on Insurance and Employee Benefits
Date:Jan 1, 2010
Words:1455
Previous Article:Policyholder other than insured.
Next Article:Survivor income benefit.

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