What to Consider When Buying Life Insurance as a Gift

Life insurance is one of the most thoughtful and impactful gifts you can give someone. Unlike traditional gifts that may lose value over time, life insurance can provide lasting financial security, potentially protecting your loved ones from financial hardship after your death. Whether you're considering buying life insurance as a gift for a family member, a child, a grandchild, or a charitable organization, it’s essential to understand what goes into this type of gift to ensure it meets both your goals and the recipient's needs.

This blog post will explore the key factors to consider when buying life insurance as a gift. It will help you evaluate the options available, select the right policy, and navigate the potential tax implications to make the most of your generous offering.

1. Understand the Purpose of the Gift

Before purchasing a life insurance policy as a gift, it’s crucial to clarify the purpose of the gift. Life insurance can serve various purposes depending on the recipient’s needs and your intentions. Some of the most common reasons for gifting life insurance include:

Providing financial security: If you're concerned about a loved one’s future and want to ensure they won’t face financial hardship after your passing, life insurance can provide a tax-free death benefit.

Funding a legacy: Life insurance can help you leave a financial legacy for children, grandchildren, or other family members, ensuring that they have the resources to pursue their goals and dreams.

Supporting a charitable cause: Some people choose to buy life insurance policies for the benefit of a charity, allowing them to make a significant donation upon their death.

Assisting with education or other expenses: If you're gifting life insurance to a child or grandchild, the policy’s death benefit could be used for their education or other essential expenses in the future.

Understanding the purpose behind your life insurance gift will guide your decision-making process, helping you choose the right type of policy, the appropriate coverage amount, and the most suitable beneficiary.

2. Choose the Right Type of Life Insurance Policy

There are several types of life insurance policies, and the choice of which one to buy as a gift will depend on the recipient's situation and your financial goals. The two most common types of life insurance are:

Term Life Insurance

Term life insurance provides coverage for a specific period (e.g., 10, 20, or 30 years). It’s typically the most affordable type of life insurance, with premiums that are lower than permanent policies. However, term life insurance has no cash value and will expire at the end of the term, unless renewed.

Pros of Term Life Insurance as a Gift:

Lower premiums, which could be beneficial if you want to keep costs manageable.

Simple structure, making it easy to understand.

No need to worry about managing cash value or investments.

Cons of Term Life Insurance as a Gift:

Coverage is only valid for the term length, meaning the recipient may outlive the policy.

It does not accumulate cash value, which can be a disadvantage if you want the gift to serve as a financial asset.

Permanent Life Insurance

Permanent life insurance, which includes whole life and universal life insurance, provides coverage for the lifetime of the policyholder. In addition to a death benefit, permanent policies accumulate cash value over time, which can be accessed through loans or withdrawals.

Pros of Permanent Life Insurance as a Gift:

Provides lifelong coverage, which could be a valuable gift for someone who may need coverage for the rest of their life.

Builds cash value, offering the potential for tax-deferred growth.

Flexibility in premium payments and benefits with universal life policies.

Cons of Permanent Life Insurance as a Gift:

Higher premiums compared to term life insurance.

Requires more attention and management due to the accumulation of cash value and investment options.

When deciding between term and permanent life insurance, consider the recipient's age, health, and long-term financial needs. For a younger beneficiary or someone who only needs coverage for a specific period (e.g., to cover a mortgage or child-rearing years), term life may be sufficient. However, for someone you want to protect over their lifetime, or if you’re seeking to create a lasting legacy, permanent life insurance may be the better choice.

3. Determine the Appropriate Coverage Amount

Once you've chosen the type of policy, the next step is determining the coverage amount. The death benefit should be sufficient to meet the financial needs of the recipient. Here are a few things to consider when determining the coverage amount:

Financial needs of the recipient: How much would your recipient need to maintain their lifestyle or cover their expenses in the event of your death? For example, if you’re gifting life insurance to a child, consider how much would be needed for their education, housing, or future financial support.

Your budget: While it’s important to select an amount that adequately covers the needs of the recipient, you must also consider how much you can afford in terms of premiums. Life insurance premiums vary significantly based on the policy’s face value, so choose an amount that fits within your budget.

Existing financial resources: If the recipient already has other sources of financial support (e.g., a retirement account, savings, or other insurance), you may be able to provide a smaller death benefit, but still ensure they are well-supported.

Consider discussing the appropriate coverage with a financial advisor to ensure that the death benefit aligns with both your goals and the recipient’s needs.

4. Selecting the Beneficiary

When buying life insurance as a gift, you'll need to decide who will be the beneficiary of the policy. The beneficiary is the person or entity that will receive the death benefit when you pass away.

Individual Beneficiaries: If you’re gifting life insurance to a family member, consider naming them as the primary beneficiary. You can also name secondary (contingent) beneficiaries in case the primary beneficiary predeceases you.

Trusts: In some cases, it may make sense to name a trust as the beneficiary, particularly if you want the proceeds to be managed in a specific way. This option can provide protection from creditors and ensure that the funds are used according to your wishes.

Charitable Organizations: If you’re interested in leaving a legacy to a cause you care about, consider naming a charity as the beneficiary. Life insurance can be a tax-efficient way to support a charity, as the death benefit is generally paid out tax-free.

Be sure to review and update the beneficiary designation periodically to ensure it aligns with your intentions.

5. Ownership of the Policy

Another important consideration when gifting life insurance is deciding who will own the policy. The owner of the policy has control over the terms of the policy, including making changes to the beneficiaries and premium payments.

Retaining Ownership: If you buy a life insurance policy for someone else but retain ownership, you will be responsible for paying the premiums. The policyholder (the person you're gifting the life insurance to) will still receive the death benefit when you pass away, but you maintain control over the policy.

Transferring Ownership: You can also transfer ownership of the life insurance policy to the recipient. This means they would be responsible for paying the premiums and making any changes to the policy. This option may be more appropriate if you want the recipient to have control over the policy long-term.

Keep in mind that transferring ownership of a life insurance policy may have tax implications, so it’s important to consult a tax professional to ensure the transfer is done correctly.

6. Understand the Tax Implications

Gifting life insurance can have tax implications for both you and the recipient. When you purchase life insurance as a gift, the premiums you pay may be considered taxable gifts. However, the IRS allows a certain annual exclusion amount for gifts, which can minimize or eliminate any gift tax liability.

Gift Tax: For 2024, the annual gift tax exclusion is $17,000 per recipient. If the premiums you pay exceed this amount, you may need to file a gift tax return. However, you likely won't owe taxes unless your total gifts exceed the lifetime exemption limit (which is $12.92 million in 2024).

Income Tax: The death benefit from a life insurance policy is generally not subject to income tax, making it a highly tax-efficient gift.

Transfer of Ownership: If you transfer ownership of a life insurance policy to someone else, it could trigger a gift tax, depending on the value of the policy and the premiums paid.

Consult with a financial or tax advisor to understand the tax implications of gifting life insurance, particularly if you're considering transferring ownership or making large gifts.

7. Consider the Long-Term Responsibility

When buying life insurance as a gift, keep in mind the long-term responsibility involved. If you retain ownership, you will be responsible for paying the premiums. If you transfer ownership to the recipient, they will be responsible for the premiums and managing the policy.

Make sure the recipient understands the financial responsibility of the policy, particularly if they are taking over ownership. If you plan to make the gift a permanent one, ensure that the recipient is financially capable of maintaining the policy.