When designing a life insurance strategy, not only is the type of policy and the amount of the death benefit essential, but proper selection of the parties to the contract is of equal importance. Why? Depending on how you structure the parties, the death benefit payable may result in unexpected tax consequences.
What’s the Goodman Triangle?
The Goodman Triangle is named after the 1946 Tax Court Case, Goodman v. Commissioner, 156 F. 2d 218 (2nd Circuit, 1946). It exists when there are three different individuals or entities named as the key parties to a life insurance contract.
- The insured: The individual whose life is covered by the policy.
- The policy owner: The person or entity that owns the policy and is typically responsible for paying the premiums.
- The beneficiary: The individual or entity who will receive the death benefit when the insured passes away.
When these roles are filled by three distinct individuals or entities, the IRS considers the death benefit — which is payable upon death of the insured — to be a taxable gift from the policy owner (who’s not the insured) to the beneficiary. It’s important to note that during the life of the insured the tax issue doesn’t arise because the policy owner maintains control of the contract, including the right to revoke or change the beneficiary. However, upon death of the insured the policy owner’s right to change the beneficiary is instantaneously terminated and the gift is completed. This timing is an important consideration if you want to unwind a structure that falls within the “Goodman trap.”
How to avoid the Goodman Triangle
Avoiding the pitfalls of the Goodman Triangle requires careful planning and attention to detail. Here are three strategies to help ensure your life insurance policy is structured in a way that minimizes tax liabilities and maximizes benefits.
1. Align ownership and beneficiary designations
One of the simplest ways to avoid the Goodman Triangle is to ensure that the policy owner and insured are the same person, or the policy owner and the beneficiary are the same person. For example, if one spouse owns the policy on their own life and names the other spouse as the beneficiary, the death benefit won’t be considered a taxable gift. This is a common structure when designing insurance plans for income replacement and family protection purposes.
2. Use a trust
Establishing a trust to own the life insurance policy can be an effective way to navigate the complexities of the Goodman Triangle. By making the trust the policy owner and beneficiary, you create a single entity that manages the policy, thus avoiding gift taxes. The trust can then distribute the benefits according to its terms, ensuring that your wishes are followed.
3. Consider gifting the policy
Another strategy is to gift the policy during the lifetime of the insured. This can help align the roles, but it’s important to be aware of potential gift taxes when transferring ownership and potential transfer-for-value issues that could cause the death benefit to be taxable.
Basic life insurance planning techniques
In addition to avoiding the Goodman Triangle, here are several basic life insurance planning techniques to consider that can help enhance your overall financial strategy:
- Review your policy regularly. When life circumstances change, so do your insurance needs. Regularly review your policy to ensure it aligns with your current financial goals and objectives. Update beneficiary designations and consider adjusting coverage as necessary.
- Understand your coverage needs. Conduct a thorough assessment of your financial situation to determine the appropriate amount of coverage. Consider factors such as debt, income replacement, future education expenses for children, estate taxes, and any other financial obligations that your family may face.
- Compare types of policies. Not all life insurance policies are created equal. Compare different policies to find the one that best fits your needs. Look at factors such as premium costs, death benefits, and any additional riders that may be beneficial.
- Consider the tax implications. Life insurance policies can have tax benefits, but they can also have significant unintended tax consequences for both the policy owner and beneficiaries. Understand these implications and plan accordingly to prevent unexpected tax liabilities and ensure your recipients obtain the maximum benefit.
- Consult with professionals. Work with an insurance professional who can provide valuable insights, help you make informed decisions, assist in structuring your policy to avoid the Goodman Triangle, and ensure that your estate planning goals are met.
Align your financial goals for peace of mind
Planning life insurance is a complex undertaking. Be cautious if three different individuals or entities are proposed as the key parties on your insurance contract; with careful attention, strategic planning, and appropriate professional advice, the pitfall of the Goodman Triangle can be avoided. By choosing proper ownership and beneficiary designations, and aligning your policy with your overall financial goals, you’ll ensure your life insurance serves its intended purpose — to achieve peace of mind and provide financial security for your beneficiaries in the years to come.
Disclosure: Securities offered through Valmark Securities Inc., Member FINRA, SIPC, 130 Springside Dr, #300, Akron, OH 44333 (330) 576-1234. Plante Moran Insurance Agency and Plante Moran Financial Advisors are separate entities from Valmark Securities.
FINRA: http://www.finra.org/
SIPC: http://www.sipc.org/
FINRA BrokerCheck: https://brokercheck.finra.org/
