Whole Life Insurance & Its Tax Benefits

How "whole life" insurance can reduce taxes and help your estate plans.

"Whole life" insurance — life insurance coverage that pays a benefit upon the death of the policyholder while also accumulating cash value — can be a useful estate-planning tool. The death benefit of a whole life policy can be used to cover estate taxes or help with business succession planning. When structured properly, the proceeds from the policy can also be free of estate taxes.

For example, a family that owns a business or property and has designated one child to take ownership can use a whole life policy to provide an inheritance to the other siblings. "One child might inherit the ranch in Colorado, and the others would get cash proceeds from the insurance policy," says Charles Bosch, Vice President and Senior Trust Advisor for Regions Private Wealth Management in New Orleans, Louisiana. Insurance can alleviate the need to sell the ranch and split the proceeds between the children or divide ownership among the siblings, some of whom may not be interested in the property.

Finding the Right Policy
Several different types of whole life coverage are available, each with its own uses and considerations:

• Traditional: Premium and death benefit are generally fixed
• Universal: Premium and death benefit can fluctuate
• Variable: Owners can invest the cash value
• Survivorship: Death benefit is paid when the second insured (usually a spouse) dies

Because most people keep whole life insurance policies for years or even decades, they'll want to know the insurer remains financially sound. One way to assess this is by regularly reviewing the carrier's ratings from an independent rating agency and ensuring the rating remains investment grade, Bosch says.

Structuring Ownership

"No matter the type of whole life insurance used within an estate plan, correctly structuring ownership of the policy is key to making sure you don't inflict a significant burden on your heirs," Bosch says. If an individual has what's known as an "incident of ownership" in a policy, such as the right to change the beneficiary, he or she is considered the owner. That typically means the death benefit will be included in his or her estate, unless state law says otherwise.

One way to avoid that is to transfer ownership to a spouse or adult child. The downside? The new owner could simply cash in the policy and spend the proceeds. Transferring ownership to a trust can help protect against this. "For as long as the trust is in effect, the death benefit will be governed according to the terms of the trust," Bosch says.

A type of trust often used to significantly reduce the estate taxes owed on benefits is an irrevocable life insurance trust, or ILIT. As the name implies, ILITs are permanent, and once established, they typically can't be changed or revoked.

Because the transfer will count against the owner's annual gift exclusion, and then against his or her lifetime exemption, it's usually best to make the transfer early in the policy's life, when the cash value is usually lower. "The smaller the cash value of the policy, the less of the exemption you use," Bosch says.

Another caveat: If the initial owner of a whole life policy passes away within three years of transferring ownership to another individual or trust, the value of the policy typically is included in his or her estate for federal estate tax purposes. One way to avoid this is for the owner to surrender the policy, purchase a new one and name a trust or another individual as the owner.

Choosing Beneficiaries

Along with structuring ownership of a policy, choosing an appropriate beneficiary is key. If no beneficiary is designated, the owner's estate may become the default beneficiary. The proceeds could be used to pay creditors and would count against the estate-tax exemption limit.

It's also critical to regularly update the designated beneficiary. For instance, if a child remains a beneficiary even after pre-deceasing a parent, that child's children — the insured's grandchildren — might not be entitled to a share of the death benefit. Instead, the money that would have gone to that child could be divided among the surviving adult children. While they may give these funds to their deceased sibling's offspring, this can generate gift-tax issues.

Whole life insurance policies can be important components of an estate plan. At the same time, the regulations surrounding them are complicated.  A Regions Wealth Advisor can help you identify the right policy and navigate the rules to ensure your policy provides the benefits you intend it to. And, as always, you will want to consult a qualified legal professional regarding the effect that a policy may have on your estate plans.

When a Policy Matures…

Some whole life insurance policies will mature before the insured person passes away. When that happens, the insurer typically must pay the maturity value, rather than a death benefit. This means that the payout could be subject to income tax, Bosch says.

To avoid this, it may be possible to extend the policy until the insured's date of death. The payout would then be classified as a death benefit, and typically not subject to income taxes. Another option is to roll the proceeds into an annuity to spread the income tax impact over several years. The proceeds or the policy could also be given to charity, thus avoiding taxation. 

While the most appropriate option will vary from one insured person to another, it's always worth reviewing your insurance policies periodically to check that they still make sense. "A regular review of your insurance coverage includes the soundness of the carrier, the soundness of the policy and a determination of your actual insurance needs," Bosch adds.


This information is general in nature, is provided for educational purposes only, and should not be interpreted as accounting, financial planning, investment, legal or tax advice or relied on for any decisions you may make. Regions encourages you to consult a professional for advice applicable to your specific situation. Although based upon information from sources believed to be reliable and accurate, Regions makes no representation or warranties with respect to the information contained herein. Opinions of authors and contributors are their own and may not reflect the position of Regions and Regions neither endorses nor guarantees any such advice, opinions, products, or services. Regions neither endorses nor guarantees any websites or companies referenced in this publication that are not owned by Regions.