Legal Definitions - incident of ownership

The term incident of ownership refers to any right or power that a person retains over a life insurance policy, even if they have formally transferred the policy to someone else. If the original owner of the policy still possesses these rights at the time of their death, the money paid out by the policy (known as the proceeds) will be included in their taxable estate for federal estate tax purposes.

Essentially, these are controls that allow the original owner to influence who benefits from the policy or to access its value. Common examples of incidents of ownership include:

• The right to change the policy's beneficiary (who receives the payout).
• The right to borrow money against the policy's cash value.
• The right to cancel the policy.
• The right to assign the policy to another person or entity.
• The right to pledge the policy as collateral for a loan.

Here are some examples to illustrate this concept:

• Example 1: Retaining Beneficiary Control

  Eleanor decides to give her life insurance policy to her daughter, Sarah, hoping to reduce her future estate taxes. However, Eleanor includes a clause in the transfer document stating that she reserves the right to change the policy's beneficiary at any time. If Eleanor passes away while still holding this right, the full value of the life insurance payout will be considered part of her taxable estate, even though Sarah was technically the policy owner. Eleanor's ability to alter who receives the benefits is an incident of ownership.

• Example 2: Power to Borrow Against the Policy

  Mark establishes an irrevocable trust for his grandchildren and transfers his substantial life insurance policy into it. Despite the transfer, the trust agreement, or the policy itself, allows Mark to take out loans against the policy's cash value whenever he wishes. When Mark dies, because he retained the power to access the policy's economic value through borrowing, the policy proceeds will be included in his gross estate for estate tax calculations. This retained financial control is an incident of ownership.

• Example 3: Ability to Cancel or Assign

  Sophia gifts her life insurance policy to a local animal shelter. However, the terms of the gift specify that Sophia retains the power to cancel the policy at any time, or to reassign it to a different charity if she changes her mind about the animal shelter. Upon Sophia's death, the proceeds from this policy would be included in her taxable estate. Her retained ability to terminate the policy or redirect its benefits demonstrates significant control, which constitutes an incident of ownership.