Life & Health Insurance Exam (National Portion)Taxes, Retirement, and Other Insurance ConceptsHard
Under what circumstances would the death benefit from a life insurance policy be included in the deceased insured's gross estate for federal estate tax purposes?
- ANever, as life insurance death benefits are always income tax-free to beneficiaries.
- BIf the policy was purchased within three years of the insured's death and transferred to another owner.
- CIf the policy's cash value exceeded a certain threshold at the time of death.
- DIf the beneficiary is the insured's spouse.
Show answer & explanationAnswer & explanation
Correct answer: B. If the policy was purchased within three years of the insured's death and transferred to another owner.
If an insured transfers ownership of a life insurance policy within three years of their death, the death benefit is included in their gross estate for federal estate tax purposes, even if they no longer owned it at death. This is known as the '3-Year Rule'.
Why the other options are wrong
- A. While death benefits are generally income tax-free to beneficiaries, they can be subject to federal estate tax under specific circumstances, such as the 3-Year Rule or if the insured retained incidents of ownership.
- C. Cash value is generally not the determinant for estate tax inclusion of the death benefit itself.
- D. The beneficiary's relationship does not directly determine estate tax inclusion; ownership and control do.
3-Year Rule (Life Insurance & Estate Tax)
A provision of the IRS Code (Section 2035) that includes the death benefit of a life insurance policy in the deceased's gross estate if the policy was transferred by the insured owner within three years of their death.
- Applies to transfers of ownership.
- Within 3 years of death.
- Death benefit included in gross estate.
- Avoids last-minute estate tax planning.
Memory trick: 3-Year Rule: Transfer Too Soon, Estate Tax Looms.