Policy Conversions & Ownership Transfers: All Things In Good Order

It was an eye-opener the first time I walked into the office of a civil engineer back in the 1970s and saw, spread across an entire wall, the flowchart mapping out the relationship and time sequence of all that was involved in getting an eight-story building there in the Burg from ground-breaking to grand-opening.
The complexity of the diagram was a mind boggle of boxes at several levels top to bottom, each containing a task that demanded completion before progression on the line to the next box was possible.
As we sit comfortably in the air-conditioned result of a similar building plan, the ease with which we can turn a tap or flip a switch seldom causes us to pause and think of all that got us there.

The order of things is essential. The correct order is critical. Fortunately the order and timing of insurance conversions and ownership transfers is less complicated.

A common planning scenario involves a personally-owned term policy where conversion is considered because of a decline in the health. The goal is to transfer the policy to an irrevocable trust either to protect the death benefit from estate taxes, creditors or spendthrift heirs – or any combination of the three!
The issue at hand is whether to convert before or after the transfer of the policy to the trust.
The answer will probably turn on the “best” fair market value for the contract.
Most advisors will probably choose to determine that the FMV of the term policy is its interpolated terminal reserve. Level term products do have a reserve to offset the “underpayment” of premium in the later years when the insured is older, but the premiums remain the same. On the other hand most advisors will determine that the FMV of the new permanent policy (in its first contract year) as premiums paid. Usually the advisor will opt for the lower of the two.
If the policy is to be gifted to the trust the lower FMV could keep the gift within sum of the available annual exclusions (usually $14,000 per trust beneficiary) to avoid the need to file a gift tax return.
If the policy is to be sold to a grantor trust (to avoid the three-year look-back), the lower FMV will require that less cash be gifted to the trust to be used by the trustee to purchase the policy from the insured/grantor.
Call us when client planning involves the combined issues of policy conversion and ownership transfer. We will assist in getting the information for determining the FMV of both policies and will assist legal and tax counsel with the information they need to properly order the transactions.
Back to the 70s – before the eight-story was completed I had gotten to know many of the workers at the job-site. They complained that working construction was too much like Christmas Day. They did all the work only to have some fat guy in a suit get all the credit.