Personally owning a life insurance policy could cause the life insurance proceeds to be included in your estate for estate tax calculation purposes. If your estate value (including the life insurance) exceeds the estate tax exemption amount1, estate taxes may be imposed on the property at your death. The estate tax must be paid by your estate within nine months after your death.
On the other hand, if your estate's taxable value (including the life insurance) is under the estate tax exemption amount1, then you may consider personally owning the life insurance policy. Estate Tax Calculator can help you estimate if your estate might be subject to estate taxes.
By shifting ownership to an irrevocable life insurance trust (ILIT), the death benefit proceeds are not included in the grantor's/insured's estate. ILITs may be used to hold the life insurance policy outside of the insured's estate. The ILIT purchases a life insurance policy on the life of the grantor/insured. The ILIT becomes the owner and beneficiary of the life insurance policy and at the death of the insured, the life insurance death benefit proceeds are paid to the ILIT free from estate and income taxes.2 The death benefit proceeds may then be used to pay estate taxes and other estate settlement costs and any remaining funds may be distributed to the beneficiaries of the trust.
Another option is to have a third‐party (i.e. an adult child) own the policy. However, it is important to note that when the owner of the life insurance policy is a third‐party, if the beneficiary dies before you (the insured), the proceeds may be paid to your estate. Naming a contingent beneficiary to the policy will ensure that the proceeds will go directly to that person, thus avoiding probate and estate taxes. The "Rule of Two" holds that a policy should always have at least two contingent beneficiaries in order to avoid such problems.
You should remember that any gift of life insurance to a third party (except to your spouse) may carry with it gift tax consequences3. Furthermore, if you make a gift of a life insurance policy it could be brought back into your estate if you do not survive your gift by three years. As the facts and circumstances of each individual varies, it it is important to consult with tax and legal counsel prior to any transfer.