Life insurance death benefits are usually income tax-free, but a policy transferred for value can lose much of that advantage. Knowing the rule, its exceptions and how to fix a tainted policy helps advisors protect clients during ownership changes.
Key takeaways
- If a policy is transferred for valuable consideration, the death benefit may be taxable except to the extent of the buyer’s basis.
- Key exceptions include transfers to the insured, a partner of the insured, a partnership that includes the insured, or a corporation in which the insured is a shareholder or officer.
- A policy tainted by a transfer for value can often be cleansed by a transfer back to the insured, since only the last transfer governs.
Consideration doesn’t have to be cash; the IRS can treat almost any benefit received in exchange for a policy as value.
What the rule says
Under Internal Revenue Code Section 101, death proceeds are generally excluded from income. But if a policy (or an interest in it) was acquired for valuable consideration, the exclusion is limited to what the new owner paid plus later premiums. The rest may be taxable income.
Consideration isn’t limited to cash. Services, other property, or any benefit given in exchange for the policy may qualify. Life settlements and business transactions are where this most often shows up.
The main exceptions
The rule does not apply when the policy is transferred to:
- The insured
- A partner of the insured
- A partnership in which the insured is a partner (including LLCs taxed as partnerships)
- A corporation in which the insured is a shareholder or officer
Transfers where the new owner’s basis carries over, such as most gifts between family members, are also generally protected. Note that a transfer to a co-shareholder is not on the list, which is a common trap in cross-purchase buy-sell planning when corporate owners swap policies.
Two common gray areas
Collateral assignments. The regulations state that pledging or assigning a policy as collateral security is not a transfer for value. Using a policy to secure a loan is generally safe; an assignment for another purpose may not be.
Beneficiary changes. The regulations focus on creating an enforceable contractual right to the proceeds. A revocable beneficiary change doesn’t create that right, so it is unlikely to be a transfer for value on its own, though there may be other reasons not to name someone in exchange for something.
Because these areas depend on facts, the client’s attorney or tax advisor should review any transfer before it happens.
How to fix a tainted policy
There is good news. A transfer back to the insured is never a transfer for value, and generally only the last transfer determines the tax result. So a policy tainted by an earlier transfer may be cleansed by transferring it back to the insured and then planning forward from there.
Keep in mind that sales of policies to unrelated parties now carry additional reporting requirements. Contact us with any questions about transferring ownership of an existing policy, and our team will help you think it through with the client’s advisors.
Frequently asked questions
What is a transfer for value in life insurance?
It occurs when a life insurance policy or an interest in it is transferred in exchange for valuable consideration. The death benefit may then be taxable except to the extent of the new owner’s basis.
What are the exceptions to the transfer-for-value rule?
Transfers to the insured, a partner of the insured, a partnership that includes the insured, or a corporation where the insured is a shareholder or officer are exceptions, as are most transfers where basis carries over, such as gifts.
Can a transfer-for-value problem be fixed?
Often yes. Since a transfer back to the insured is never a transfer for value and generally only the last transfer counts, moving the policy back to the insured can cleanse it. Clients should confirm with their tax advisor.
Reviewed by Tim Fuller on 2026-09-26
Tim Fuller
President, SRS Inc.
Tim leads SRS Inc., a full-service IMO (Independent Marketing Organization) and BGA (Brokerage General Agency), connecting independent financial professionals with life, annuity, disability income, and long-term care solutions from 60+ carrier partners.
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