A life insurance policy is generally set up in one of two ways:

  1. Owner and insured are the same person; primary beneficiary is a different person
  2. Owner and primary beneficiary are the same person; insured is a different person

The reason for this is to allow the proceeds from the policy to be kept out of the insured’s gross estate.  When the owner, insured, and beneficiary are three different individuals, and the insured passes away, you may get hit with unintended, but significant, estate taxes, gift taxes, or income taxes – this is commonly referred to as the “Goodman Triangle“.

A couple of the most common occurrences when this can happen is 1) when a spouse purchases a policy on the other spouse and wants to name their children as beneficiary or 2) a child takes out a life insurance policy on a parent and names himself and his siblings as primary beneficiaries.

The thought process behind this is the policyowner is making a gift to the beneficiary at the death of the insured.  While the insured is alive, the policyowner is making an incomplete gift with the payment of premiums because he can still change the beneficiary at any time.  However, once the insured dies, he loses the ability to change the beneficiary, thus the incomplete gift becomes a completed gift and the proceeds are paid out.

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