Community Property and Life Insurance

Anyone familiar with estate planning can attest to the confusion that community property rules often cause married couples. For those married individuals either living in, or considering moving to, one of the community property jurisdictions, the issue strikes a little closer to home. And, nowhere is this more evident than the case of how the community property rules affect life insurance planning.

Currently, nine states are community property jurisdictions—Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. In addition, Puerto Rico is a community property jurisdiction. In general, this means that property accumulated during marriage is to be split equally. However, property either spouse owned before marriage, or after a separation, is considered separate property. Meanwhile, Mississippi bases property division on who holds the legal title and—if jointly owned—the property is equitably divided. All other states and the District of Columbia use some form of equitable distribution based on “fairness.”

One issue on which there is no uniformity in the various community property states is the status of income from separate property: Some say that the income is separate property, while others say that it is community property.

These rules can often impact mobile couples without their realizing it. For example, if a couple who formerly lived in a community property state moves to a non-community property state, their property may still be considered by the Internal Revenue Service (IRS) to be community property unless the couple does something to the contrary. When a couple moves from a non-community property state to a community property state, their assets acquired in the non-community property state retain their former status as either separately or jointly held.

What About Life Insurance?
With this said, however, the community property rules by themselves only go halfway toward the understanding of how the ownership of life insurance in a community property state impacts an individual’s federal gross estate. Married couples living in a community property state need to understand that only one-half of their interest in community property will be included in their federal gross estates. Given this general rule, understanding how life insurance operates in a community property state is relatively straightforward.

For example, if the policy was purchased with community funds and the insured spouse dies, one-half of the proceeds will be included in the insured’s federal gross estate. In the case where the insured dies owning the policy and names his or her probate estate beneficiary, the insured’s executor receives the full amount of the policy proceeds, only one-half of which is includable in the insured’s gross estate. Interestingly, the surviving spouse has a legal claim to one-half of the proceeds under community property principles, since one-half of the proceeds are deemed to belong to the surviving spouse.

A strange result can occur when community funds are used to purchase a policy and the surviving spouse is not made the beneficiary of the full proceeds. In this case, the IRS believes that although one-half of the proceeds are includable in the deceased spouse’s federal gross estate, in certain circumstances the surviving spouse may have made a gift of that spouse’s half of the proceeds to the named beneficiary.

While this is a curious result, a more difficult question arises on what is included in the decedent’s gross estate where the premiums have been paid with community and separate funds. The answer to this question depends on which state the decedent lived in, because the community property jurisdictions take different approaches.


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