LIFE RIDERS, PROVISIONS, OPTIONS · 6 MIN READ

Death Proceeds, Policy Sales, and Estate Strategies

Death proceeds are generally excluded from the beneficiary's gross income, but the transfer-for-value rule destroys that exclusion when a policy is sold: if a policy is transferred for valuable consideration, the buyer's exclusion at death is limited to the consideration paid plus subsequent premiums, and the rest of the proceeds is ordinary income. Exceptions preserve the full exclusion for transfers to the insured, a partner of the insured, a partnership including the insured, a corporation in which the insured is a shareholder or officer, and carryover-basis transfers — the classic planning error is routing a policy among an owner, insured, and beneficiary triangle in a way that misses every exception. Viatical settlements are the compassionate carve-out: when a terminally ill insured (certified life expectancy of 24 months or less) sells the policy to a licensed viatical settlement provider, the entire sale price is treated as death proceeds and is income tax free; chronically ill sellers get the same treatment only for amounts tied to qualified long-term care. Ordinary life settlements by healthy seniors are taxable transactions, and settlement providers must disclose alternatives (such as accelerated benefits and policy loans), tax consequences, creditor and Medicaid effects, and a rescission right before or at the settlement application. Anti-STOLI rules block investor-initiated policies, typically by prohibiting settlement of a policy within its first two years absent hardship exceptions. Estate planning uses trusts to keep proceeds out of the taxable estate. An Irrevocable Life Insurance Trust (ILIT) owns the policy so the insured holds no incidents of ownership; however, transferring an existing policy into the trust within three years of death pulls the proceeds back into the estate under the three-year look-back. Premium gifts to the ILIT qualify for the annual gift-tax exclusion only if beneficiaries hold Crummey withdrawal powers — a temporary right (typically 30 to 60 days) to withdraw each contribution, converting a future-interest gift into a present interest. Advanced wealth-transfer vehicles appear on the exam at the recognition level. The generation-skipping transfer tax hits gifts to skip persons — grandchildren whose parent is still living, or unrelated persons more than 37 1/2 years younger — subject to a lifetime GST exemption ($13.99 million in 2025). A zeroed-out GRAT retains a qualified annuity whose present value equals the transferred property, producing a near-zero taxable gift. An intentionally defective grantor trust (IDGT) makes the grantor pay income tax on trust income — effectively an extra tax-free gift, since the tax payment is not treated as a gift. Spousal lifetime access trusts, family limited partnerships (valuation discounts), and qualified personal residence trusts round out the toolkit.