193 / Can life insurance settlements naming the spouse as primary beneficiary and other persons as contingent beneficiaries be arranged so that the proceeds qualify for the marital deduction?

Yes.

When there is a possibility that one or more persons may receive some unpaid proceeds after the spouse’s death, the spouse receives only a terminable interest in the proceeds. As a rule, terminable interests do not qualify for the marital deduction. As an exception to the general rule, however, a settlement naming contingent beneficiaries will qualify if the spouse is given a general power of appointment over the proceeds and certain other requirements are met.

Specifically, an insured may elect an interest-only, life income, or installment option for his or her spouse, naming contingent beneficiaries to receive the proceeds after the spouse’s death, and the proceeds will qualify, provided the settlement meets the following conditions:

(1)     The interest or installments must be payable annually or more frequently, and the first payment must be payable no later than 13 months after the insured’s death;

(2)     All amounts payable during the spouse’s life must be payable only to the spouse;

(3)     The spouse must have a general power of appointment over the proceeds (a power to appoint the proceeds to himself or herself or to his or her estate – see Q 194);

(4)     The spouse’s power to appoint must be exercisable by the spouse alone and in all events, whether exercisable by will or during life; and

(5)     The proceeds must not be subject to a power in any other person to appoint against the spouse.¹

An alternative settlement naming contingent beneficiaries does not require that the spouse be given any power over the proceeds so long as the spouse has a “qualifying income interest for life” in the proceeds, and so long as the executor elects to have such proceeds qualify for the marital deduction. The surviving spouse has a “qualifying income interest for life” if he or she is entitled to all the income from the proceeds, payable annually or more frequently, and no person has a power to appoint any part of the proceeds to any person other than the surviving spouse. The insured or anyone else, including the surviving spouse, can designate beneficiaries to receive proceeds remaining at the spouse’s death, and the spouse may be (but need not be) given the right to withdraw proceeds during his or her lifetime ( Q 191).

It is not necessary that the entire proceeds qualify. If a specific portion of the proceeds meets the conditions outlined above, that specific portion will qualify for the deduction.²

The specific portion, however, must be determined on a fractional or percentage basis.³