Disadvantages of Third Party Ownership of Life Insurance

Planners must not let the advantages to third party ownership totally obscure the potential risks or costs. These disadvantages generally fall into two categories.

First, the client must give up direct control over the policy through a complete and permanent transfer to avoid the federal estate tax. An absolute assignment or total change of ownership must be made if a presently existing policy is to be removed from the client’s estate. This means the client must forgo the right to name or change the policy beneficiary, veto a change, borrow against the cash values of the policy, and give up every other meaningful and significant incident of ownership.

Many events, unpredictable at the time third party ownership is arranged, can drastically change the way or the parties the client would prefer to own coverage on his life. For instance, the insured’s marriage could become unstable, the insured may no longer get along with the children who are the owners of a policy on the insured’s life, or the insured’s spouse or other owner could predecease the insured. The insured may remarry. Tax laws can change. During this time, the insured may become highly rated due to health problems or even become uninsurable or insurable only at prohibitive cost. Business reverses or opportunities may suggest a need for insurance cash values, which are unavailable if the policy is no longer owned by the insured.

Reproduced with permission.  Copyright The National Underwriter Co. Division of ALM

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