At a recent extension event, a question was raised about whether an individual's life insurance policy placed on themselves was considered part of the 'gross estate,' which is subject to the estate tax. As with all legal questions, the answer is that 'it depends.'
As a bit of a refresher, an individual's gross estate consists of the assets owned by that individual at the time of their death, which can include their personal property and real property, even when such property is owned through a revocable trust or a business entity such as an LLC. Every individual receives a certain exemption against the estate tax (i.e., the amount of property that can be included in your gross estate before the estate tax is levied on the excess). In 2025, the exemption amount is $13.98 million for individuals and $27.98 million for married couples. In other words, if an unmarried individual were to pass away in 2025 with a gross estate valued at $14.98 million, the estate tax would be levied against $1,000,000 of that individual's gross estate, since the first $13.98 million was exempt.
For many people, life insurance is a means to either bypass the estate tax or help their loved ones pay the estate taxes owed at the time of their death. While there is merit to that strategy, the life insurance policy needs to meet certain qualifications to avoid itself being includible in the gross estate.
Specifically, there are two requirements that a life insurance policy must satisfy in order to avoid being included in the gross estate (and thus potentially subject to the estate tax):
(1) The life insurance policy must not pay proceeds to the insured's estate. In other words, the life insurance policy needs beneficiaries other than the person whose life the policy is based around. Generally speaking, this usually looks like a father buying a policy based on his life, putting his wife as the primary beneficiary, and then his children as the contingent beneficiaries (i.e., the beneficiaries who receive the proceeds if the wife dies before the husband, or if both die in a simultaneous incident like a car wreck). If the life insurance policy does not list a beneficiary, it is likely that the life insurance proceeds will go to the policyholder's estate and thus be includible in the gross estate (and subject to the estate tax, at least if the gross estate exceeds the exemption).
AND (not or - the policy must meet both requirements)
(2) If the insured (i.e., policyholder) retains any "incidents of ownership" over the policy in the three years prior to the policyholder's death, the life insurance policy will be includible in the gross estate. Incidents of ownership vary in nature, but essentially, the policyholder, after purchasing the policy, cannot retain the right to:- Change beneficiaries
- Assign the policy (or revoke the assignment)
- Pledge the life insurance as collateral for a loan
- Borrow against the life insurance's cash surrender value
- Surrender or cancel the policy
The above-stated rule arises out of Internal Revenue Code Section 2042 and its related regulations.
