Third-party ownership of life insurance

Correct answer: Someone other than the insured owns a policy on that insured's life

Third-party ownership is defined by who holds the ownership rights, not by who receives the money. When the policyowner is anyone other than the insured — an employer, a business partner, a trust, a parent, a spouse — the arrangement is third-party ownership. When owner and insured are the same person, the coverage is first-party or insured-owned.

Correct answer: Decline, because naming and changing the beneficiary is an ownership right that belongs to the employer

The insurer takes direction only from the policyowner. Naming and changing the beneficiary is one of the ownership rights, along with paying premiums, borrowing against cash value, assigning, and surrendering. Maria is the insured, and an insured who is not the owner holds no policy rights. Only the employer may request the change.

Correct answer: At the time the policy is applied for

Insurable interest must be present when the policy is applied for. It is not required to survive until the insured's death — a policy is not voided merely because the relationship later ends, for example when an employee leaves or a marriage ends. Without insurable interest at application, the contract is an unenforceable wager on a human life.

Correct answer: A sale of the policy to a partnership in which the insured is a partner

The exceptions to the transfer-for-value rule include transfers to the insured, to a partner of the insured, to a partnership in which the insured is a partner, to a corporation in which the insured is a shareholder or officer, and transfers in which the transferee's basis is determined by reference to the transferor's basis. A sale to a partnership in which the insured is a partner fits squarely within that list.

Correct answer: Generally not deductible

Premiums paid by a third-party owner on life insurance are generally not deductible. The trade-off is on the other side of the transaction: the death proceeds the corporate beneficiary receives because of the insured's death are generally excluded from gross income.

Correct answer: A cross-purchase buy-sell plan, requiring six individually owned policies

In a cross-purchase plan each business owner personally owns a policy on each of the other owners — classic third-party ownership among individuals. With three owners, each owning coverage on the other two, six policies are needed. If the business itself owned the contracts, it would be an entity plan.

Correct answer: Luis must consent to the coverage on his life

When a third party applies for coverage on another person's life, the insured's consent is required in addition to the applicant's insurable interest. Luis is the subject of underwriting and must sign, but consenting gives him no ownership rights — Ana as owner keeps the right to name the beneficiary, borrow, assign, or surrender.

Correct answer: $75,000

Death proceeds are generally excluded from the beneficiary's gross income, but the transfer-for-value rule limits the exclusion when a policy is transferred for valuable consideration. Only the consideration paid plus premiums paid afterward escape tax: $20,000 plus $5,000, or $25,000. The excess, $75,000, is taxable income.

Correct answer: A corporation applies for, owns, and pays premiums on a policy insuring its chief engineer, with the corporation as beneficiary.

Third-party ownership exists whenever someone other than the insured owns a policy on that insured's life. A corporation that applies for, owns, and pays for key person coverage on an employee is a third-party owner; the insured employee holds no policy rights.

Correct answer: At the time the policy is applied for.

Insurable interest must be present when the policy is applied for. If it does not exist at that time, the contract is an unenforceable wagering agreement; it need not continue to exist at the insured's death.

Correct answer: Refuse the request, because only the trustee, as policyowner, may exercise the loan right.

Policy rights follow the owner. Because the trust owns the contract, only the trustee may borrow, surrender, assign, or change the beneficiary. The insured holds no policy rights unless she is also the owner.

Correct answer: Only the consideration paid plus premiums paid after the transfer are excluded; the excess is taxable income.

This is the transfer-for-value rule. When a policy is transferred for valuable consideration and no exception applies, the income exclusion for death proceeds is limited to the consideration paid plus premiums paid after the transfer; the excess is taxable income.

Correct answer: The employer may apply for, own, and be beneficiary of the policy because it has a lawful economic interest in the employee, and the employee must consent.

Key person insurance is third-party ownership supported by an employer's lawful economic interest in the employee. Insurable interest must exist at application, and the insured's consent is required when another person applies for coverage on his or her life.

Correct answer: Each owner applies for and owns a policy on each of the other owners' lives.

In a cross-purchase plan the individual owners are the third-party policyowners: each owner buys and owns coverage on the other owners' lives. In an entity plan, by contrast, the business owns the policies.

Correct answer: Generally not deductible.

Premiums paid by a third-party owner on life insurance are generally not deductible, even though the death proceeds are generally excluded from the beneficiary's gross income.

Correct answer: The insured must sign to consent to the application; the owner signs to make later changes such as a beneficiary change or policy loan.

When a third party applies for coverage, the insured must consent by signing the application; after issue, all contractual rights belong to the owner, so the owner's signature controls beneficiary changes, loans, assignments, and surrenders.

Correct answer: Someone other than the insured owns the policy on the insured's life

A life policy involves three roles — owner, insured, and beneficiary. When the owner and insured are the same person the coverage is called first-party or insured-owned. Third-party ownership means the owner is someone other than the insured, such as an employer, a business partner, a trust, or a family member.

Correct answer: Refuse the request, because only the policyowner may change the beneficiary

All contractual rights — naming and changing the beneficiary, assigning, surrendering, borrowing, and selecting settlement options — belong to the policyowner. The insured who is not the owner has no such rights, so the insurer takes direction only from the mother.

Correct answer: At the time the policy is applied for

A third-party applicant must have an insurable interest in the insured — a close family relationship or a lawful economic interest such as that of an employer, business partner, or creditor — at the time the policy is applied for. It need not continue until death; a contract issued without insurable interest at inception is an unenforceable wager.

Correct answer: Key person insurance, a common form of third-party ownership

When an employer owns coverage on a valuable employee, pays the premiums, and collects the proceeds, that is key person insurance — a textbook example of third-party ownership supported by the employer's lawful economic interest in the employee.

Correct answer: A transfer to a partnership in which the insured is a partner

Recognized exceptions to the transfer-for-value rule include transfers to the insured, to a partner of the insured, to a partnership in which the insured is a partner, to a corporation in which the insured is a shareholder or officer, and transfers in which the transferee's basis is determined by reference to the transferor's basis. A sale to a partnership in which the insured is a partner therefore keeps the full income-tax exclusion for the death proceeds.

Correct answer: It is a cross-purchase plan, and each policy is a third-party-owned contract

When each business owner personally owns policies on the other owners, the buy-sell is funded on a cross-purchase basis. Because the owner of each contract is someone other than its insured, every policy is a third-party-owned contract, supported by the co-owners' lawful economic interest in one another.

Correct answer: The partner's consent to the coverage

When one person applies for coverage on another's life, the proposed insured must consent to the coverage in addition to the applicant having an insurable interest. The insured is also the subject of underwriting and signs the application, even though he or she holds no ownership rights.

Correct answer: The premiums are not deductible, and the death proceeds are generally excluded from gross income

Premiums paid by a third-party owner on a personal life insurance policy are generally not deductible, while amounts received under a life insurance contract by reason of the insured's death are generally excluded from the recipient's gross income. Trust ownership does not change either rule, absent a transfer for value.

Correct answer: Someone other than the insured owns the policy on that insured's life

A life policy involves three distinct roles — owner, insured, and beneficiary. When the owner and the insured are the same person, the coverage is first-party or insured-owned. Third-party ownership is defined simply by the owner being someone other than the insured, such as an employer, a trust, a business partner, or a parent.

Correct answer: Decline, because only the trust, as policyowner, may change the beneficiary

Contractual rights — including naming and changing the beneficiary — belong to the policyowner. In a trust-owned arrangement the trust is the owner, and the insured deliberately holds none of the ownership rights. The insurer takes direction only from the owner, so Maria's request must be declined.

Correct answer: Must exist when the policy is applied for, though it need not still exist at the time of death

Under the Texas Insurance Code provisions governing life insurance, the applicant must have an insurable interest — a close family relationship or a lawful economic interest such as that of an employer, business partner, or creditor — at the time the policy is applied for. Without it, the contract is an unenforceable wager. Insurable interest is not retested at the insured's death.

Correct answer: The corporation is the policyowner with all contractual rights, and the CFO must consent to the coverage

Key person insurance is a textbook third-party ownership case: the employer applies for, owns, pays for, and is the beneficiary of coverage on a valuable employee. The employer's lawful economic interest supplies insurable interest under the Texas Insurance Code, and because someone other than the insured is applying, the insured's consent is also required.

Correct answer: Transfer of the policy to a partner of the insured

Death proceeds are generally excluded from the beneficiary's gross income, but the transfer-for-value rule limits that exclusion when a policy is transferred for valuable consideration. Recognized exceptions include transfers to the insured, to a partner of the insured, to a partnership in which the insured is a partner, to a corporation in which the insured is a shareholder or officer, and transfers with a carryover basis. A transfer to a partner of the insured falls squarely inside the list.

Correct answer: Generally not deductible by the third-party owner

Premiums paid by a third-party owner of life insurance are generally not deductible for federal income tax purposes. The tax advantage of life insurance is on the benefit side — death proceeds paid because of the insured's death are generally excluded from the beneficiary's gross income — not on the premium side.

Correct answer: Each owner owns a policy on each of the other owners' lives

In a cross-purchase buy-sell plan the owners buy each other out personally, so each business owner is the third-party owner of a policy on each of the other owners' lives. When the business itself owns the policies, the arrangement is an entity plan instead.

Correct answer: Decline the request, because only the policyowner may borrow against the cash value

The insurer takes direction only from the owner. Borrowing against cash value, like changing the beneficiary, assigning, or surrendering the contract, is an ownership right. The insured holds no such rights unless he is also the owner. If the grandmother wishes to hand over control, she can transfer ownership by absolute assignment; ownership does not shift by itself.

Correct answer: Someone other than the insured owns the policy on that insured's life

Ownership, not beneficiary designation or who physically pays, defines the arrangement. When the owner and the insured are the same person, the coverage is first-party or insured-owned; third-party ownership exists whenever the policyowner is someone other than the insured, such as an employer, trust, spouse, or business partner.

Correct answer: Only the trustee, because the trust is the policyowner

Contractual rights follow the owner. Borrowing against cash value is an ownership right, so only the trust, acting through its trustee, can exercise it. The insured holds no policy rights unless he is also the owner — which is precisely the result trust ownership is designed to avoid.

Correct answer: At the time the policy is applied for

Under the Texas Insurance Code provisions governing life insurance, the applicant must have an insurable interest — close family relationship or a lawful economic interest such as employer, business partner, or creditor — when the policy is applied for. Without it, the contract is an unenforceable wager. Insurable interest is not required to continue, so a policy remains valid if the relationship later ends, for example after employment terminates or a divorce.

Correct answer: Key person insurance

Key person insurance is the classic third-party ownership case: the employer applies for, owns, pays for, and is the beneficiary of a policy on a valuable employee, protecting the business against the economic loss of that person. The employer's economic interest in the employee supplies the required insurable interest.

Correct answer: Sale of the policy to a corporation in which the insured is a shareholder

Death proceeds are generally excluded from the beneficiary's gross income, but the transfer-for-value rule cuts that exclusion back when a policy is transferred for valuable consideration. Recognized exceptions include transfers to the insured, to a partner of the insured, to a partnership in which the insured is a partner, to a corporation in which the insured is a shareholder or officer, and transfers where the transferee's basis carries over from the transferor. A sale to a corporation in which the insured is a shareholder fits squarely within that list.

Correct answer: Premiums are generally not deductible, and the death proceeds are generally excluded from gross income

Premiums a third-party owner pays on life insurance are generally not deductible when the payer is directly or indirectly a beneficiary of the policy, and amounts received under a life insurance contract by reason of the insured's death are generally excluded from gross income. Both halves of the answer must be correct.

Correct answer: It is a cross-purchase plan, and each policy is third-party owned because the owner is not the insured

In a cross-purchase buy-sell plan each business owner individually owns a policy on each of the other owners; the business owns nothing. Because the owner of each policy is never the insured, every policy is a third-party ownership arrangement, and each owner's lawful economic interest as a co-owner supplies the insurable interest required at application.

Correct answer: Both the wife's as applicant and the husband's, because the proposed insured must consent

When a third party applies for coverage on another person's life, the applicant signs as the prospective owner and the proposed insured must also consent to the coverage, since he is the subject of underwriting. Insurable interest — here the spousal relationship — is necessary but not sufficient; consent is separately required. The memory hook: the insured's signature is needed to apply, the owner's signature is needed to change anything afterward.