Insurance and therefore the Three-Year Rule

Beginners in estate planning are sometimes taken aback to learn that the investment they must make in a tax-free life insurance policy will be counted towards their taxable estate. An irrevocable transfer of legal ownership and benefits to a newly created trust, which can become the policy's new owner and beneficiary, is the only way to avoid estate taxes (with its high marginal rates). Because they are the trust's beneficiaries, people are frequently established.


Estate planners frequently advise their clients that they must survive for a minimum of three years after transferring ownership and benefits of an experienced policy (i.e., a policy that is already in effect) to an irrevocable life assurance trust in order to avoid being included in the client's estate. The value of a decedent's estate must be calculated in accordance with IRC section 2042, one of the sections mentioned in IRC section 2035, and includes the proceeds of extra security "to the degree of the sum got by any remaining recipients as insurance under contracts on the lifetime of the decedent as for which the decedent at death possessed any of the incidents of ownership, exercisable either alone or in conjunction with the other person.".... When estimating the value of a potential that the policy or proceeds may also be subject to the deceased's influence over disposal, such a possibility must be assessed as though there were a chance that the policy or profits could be returned to the decedent or estate.

The life assurance insurance must be transferred to the trust, and the trust's drafter must make sure that no ownership incidents remain with the insured.

Furthermore, estate taxes shouldn't be charged to an irrevocable life assurance trust. This contractual duty would return the insurance payments to the decedent's taxable estate in accordance with Treasury regulations section 20.2042-1. The life insurance proceeds, on the other hand, won't be included in the decedent's taxable estate if the trust is permitted to either lend money to or purchase assets from the estate, and the estate will have the cash necessary to pay taxes.

Whether whole life, variable life, universal life, or a combination of these, all insurance plans are actually insurance policies with a separate investing provision encased within a single contract. Since they were presented as a single investment package, the three-year rule undoubtedly applies to them. But what about insurance coverage? IRC section 2035(d)'s three-year limit applies to insurance, right?

The three-year rule is considered in terms of the transfer of a policy under the IRC and consequently the Treasury regulations issued thereunder. But insurance essentially provides coverage from year to year; it must be renewed and replaced every year. …

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