Life Insurance Life insurance tax surprise: The unholy trinity Written by: Barbara Marquand | Reviewed by: Les Masterson Les Masterson Les, a former managing editor, insurance, at QuinStreet, has more than 20 years of experience in journalism. In his career, he has covered everything from health insurance to presidential politics. | Updated on March 21, 2019 Why you should trust Insure.com Quality Verified At Insure.com, we are committed to providing honest and reliable information so that you can make the best financial decisions for you and your family. All of our content is written and reviewed by industry professionals and insurance experts. We maintain strict editorial independence from insurance companies to maintain editorial integrity, so our recommendations are unbiased and are based on a comprehensive list of criteria. A major plus with life insurance is that the death benefit is usually tax-free. Your beneficiaries receive the money and don’t have to worry about a cut going to Uncle Sam. But there’s an exception you should know about if you’re planning to buy life insurance and want to protect yourself from a gift tax. The tax trap is known as the “unholy trinity” or “the Goodman Triangle” after a 1946 court case, Goodman v. Commissioner of the Internal Revenue Service. It happens when three different people play the roles of policy owner, insured and beneficiary. Think of a life insurance policy as a triangle, says Amy Rose Herrick, a Chartered Financial Consultant and founder of the Money With Amy website. The three points of the triangle are as follows: The policy owner — the person who bought the policy and pays the premiums. The insured — the person whose life the policy covers. The beneficiary — the person designated to receive the death benefit when the insured dies. “You always want two points of the triangle to be the same person, company or charity,” Herrick says. If there are three different people at the three points, then the death benefit could count as a taxable gift to the beneficiary. How to avoid the tax trap For example, a husband owns a policy on his wife’s life and names their son the beneficiary. The wife dies, and the son receives the benefit amount. In the eyes of the IRS, since the husband was the owner of the policy, he has given a gift of the benefit to his son – making it a taxable gift amount. The person who makes the gift — the policy owner, not the beneficiary — is the one who could be subject to gift taxes. Whether any tax is owed depends on how much is given away. Under federal tax law, you can give a certain amount every year and over a lifetime tax-free to someone. In 2018, the annual limit is $15,000 per recipient. That’s an increase from $14,000 in 2017. The lifetime amount, known as the basic exclusion, is $11.18 million for 2018. That’s an increase from $5.49 million in 2017. Therefore, a married couple can give away $22.36 million over their lifetimes without paying gift taxes. (Money and property transferred to spouses is not taxed.) These huge exclusion increases were part of the federal tax overhaul. To avoid the triangle, in the example above, the wife could be both the policy owner and the insured party. Then, she could name the son the beneficiary. The benefit amount would not be considered a taxable gift. However, if the death benefit is included in her estate, and the value of the estate exceeds state or federal estate tax exemption amounts, then it could be taxed. In the event that the estate would be valued higher than the exemption amount, one solution may be having an irrevocable life insurance trust be the owner of the policy. The unholy trinity trap is often overlooked, Herrick says. Even some life insurance salespeople are unaware of it, and it can occur with term life or permanent life insurance. Life insurance should be part of a holistic financial plan. Work with a savvy adviser when you purchase coverage because estate planning and tax issues are complex, especially when you have a large estate. Related Articles Burial insurance: What it is and how it works By Nupur Gambhir Life insurance basics By Erik Martin 6 types of term life insurance policies By Nupur Gambhir Life insurance riders: What they are and how they work By Laine Adley Life insurance for women By Huma Naeem The life insurance contestability period: What you need to know By Laine Adley Get instant quotes now ! Please enter valid zip Get quote