The Bermuda Triangle of Life Insurance Benefits, The Goodman Triangle
Life insurance and the Goodman Triangle is an important topic when considering your life insurance designations. One significant benefit of life insurance is that the death benefit is usually tax-free. The beneficiaries receive the death benefit, and no one worries about paying any taxes on the proceeds.
For most people, naming the beneficiary for life insurance is an “autopilot” decision. The primary beneficiary is your spouse, and the contingent beneficiaries are your children. It is that simple. Others name the estate. Note: If you are purchasing life insurance on your parents or are purchasing life insurance on elderly parents, your beneficiary designation is especially important.
Once the primary and contingent beneficiaries are designated, we neglect the importance of reviewing and updating them. Children get married and change last names, other beneficiaries pass away and are still designated as contingent beneficiaries. An exception to be aware of, improper ownership and beneficiary designations can cause the death benefit to be considered a gift tax by Uncle Sam. Most people are unaware of a tax surprise called the “Goodman Triangle.”
The Goodman Triangle is like the Bermuda Triangle; unexpected consequences can occur when encountered. If you have ever been at sea in the Bermuda Triangle, you know what I am talking about, I’ve been there as a navigator. You plan for one destination but somehow end up in another destination you did not plan for. Unplanned and unintended consequences can occur when three different people are involved as the policy owner, insured, and beneficiary.
Three Points of The Triangle
To clarify the three points of the triangle, The Insured is the person whose life the policy covers. The owner is the person who bought the policy and paid the premiums. The Beneficiary is the person designated to receive the death benefit when the insured dies. These are the three points of the triangle. The problem occurs when there are three different people at the three points of the triangle. The death benefit could count as a taxable gift to the beneficiary.
The Solution to The Problem
An easy solution is to always have two points of the triangle to be the same person. In theory, making someone else the owner, other than the insured, could help prevent the policy from being included in the insured’s gross estate. However, when the owner of the policy is not the insured and not the only beneficiary, gift taxes may apply.
For example, the gift tax can come up when one spouse owns a policy on the other spouse and then names the children as beneficiaries. Or when an adult child takes a policy out on a parent and names himself and his siblings as beneficiaries. In both situations, the thought is, since the insured never owned the policy, the proceeds will not be included in the gross estate. Everyone lives happily ever after, and the benefits go on to do what it was intended to accomplish.
However, this is a common problem where, one child owns a policy on a parent’s life, and other children are named beneficiaries. Consider this common situation; purchasing a significant life insurance policy and creating a source of liquid assets for the children. One child lives closer than the others; they live in different states.
So, the child who lives locally is named the owner, all three are designated beneficiaries. When the surviving parent dies, each child receives their share. But the child who owns the policy may be regarded to have made a taxable gift to his siblings when the benefit is paid. To avoid the negative consequences why not avoid the ‘triangle” in the first place, always have two points of the triangle as the same person.
An Insurable Interest
A life insurance beneficiary is a person or entity that will receive the proceeds of your life insurance policy die. As the owner of the life insurance policy, you can usually name anyone you want. However, an insurable interest must exist for a beneficiary to be named in your policy. An insurable interest is a relationship in which one party will suffer financial loss in the event of your death.
When you purchase a life insurance policy, there must be an insurable interest between you and the person whose life you are insuring or designating as your beneficiary. Insurable interest protects against someone who has no interest in your life profiting from your death.
Don’t Forget to Review Your Beneficiaries!
After policies are issued and time has passed, I have been amazed that clients do not remember who the beneficiaries of their insurance policies are. It would seem like a given that everyone would know who they named, but they amazingly do not. If they know who the primary beneficiaries, they have forgotten who the contingent beneficiaries are.
Don’t for the review the contingent beneficiaries they are very important also. Think about it; if you and your primary beneficiary die in a single accident, the contingent becomes the beneficiary of your life insurance proceeds. Be sure to take the time to review the beneficiaries that you have on your policies and your financial instruments.
Factors to take into consideration that may require a beneficiary update are a marriage, birth of a child, divorce, and the death of named beneficiaries. Life moves forward, and beneficiaries need to be updated. For more information on naming beneficiaries to check out “Beneficiaries 101.”
Beneficiary change forms are readily available for all insurance policies through the insurance company. Although forms are updated occasionally by insurance companies, it is a good idea to have an extra current copy of the change form available and keep it with your insurance policy. This can save you time where a change is needed.
You have made an effort to purchase an insurance policy protecting your family; it only makes sense to review your insurance policy beneficiary designations. Reviewing your policies will make sure the death benefits go where you intend them to go and where they are needed.
Naming the Estate as Beneficiary
Some clients neglect to name a specific beneficiary and name the estate as the beneficiary. This could result in your assets going through the ugly probate process. Probate is the legal process for distributing your assets after death. It usually will not benefit the beneficiaries, is time-consuming, and expensive. It is another hoop for your family to jump through that is unnecessary at this emotional time.
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No Need for Face-To-Face Meetings
Changes in technology have brought about many changes in the life insurance industry. One difference is the elimination of face-to-face meetings with an insurance agent. This meeting is no longer necessary. Although some companies still require that the agent and client meet. However, many insurance companies have eliminated the requirement. Today companies have incorporated e-signature and “DocuSign” via the internet as well as using voice signature, a more advanced approach to getting a policy issued.
Use an Independent Agent Rather Than a Captive Agent
A captive agent must offer you products from the company that has “captured” and contracted them to solicit only their insurance. There might be better options for your insurance protection, but the agent is restricted from offering them to you. Captive agents limit your choices of finding the best company at the best price, with the quickest approval time. Also, be aware of many of the larger agencies that continuously advertise on the radio, etc. which in reality only represent a handful of companies.