One of the key benefits of any kind of life insurance is the tax-free death benefit. However, some speculators began to transfer life insurance policies between parties in order to reap large tax-free windfalls. In order to discourage this, Congress declared that any life insurance policy that is transferred for any kind of material consideration may become partially or fully taxable when the death benefit is paid out.
This rule is known as the transfer-for-value rule, and it stands as one of the few exceptions to the general exemption from taxation accorded to all life insurance death benefit proceeds. However, the rule itself has several exceptions. We will examine these exceptions as well as the conditions under which a policy transfer may result in taxation. (Tough times call for desperate measures, but is raiding your life insurance policy even worth considering? To learn more, read Cashing In Your Life Insurance Policy.)