What Is Third Party Life Insurance?

Life insurance agent <a href= on the phone, answering the question, what is third party life insurance?" width="" height="" />

What is third party life insurance? It’s when the policy owner, the person who pays for the policy, and the insured person are not necessarily the same. We’ll explain when this happens, and who can benefit from this type of arrangement.

What Is Third Party Life Insurance?

Third party life insurance is when three or more people (or entities) share the four roles inherent in a policy, as opposed to the more traditional usage, where two people (or entities) fill those roles.

Every life insurance policy revolves around four roles:

Happy parents standing with their daughter, who is their life insurance beneficiary.

Not every policy has four distinct people or entities in each role. Most don’t, in fact. But there are certain situations, especially in a business context, where having these distinct roles makes life insurance a financial tool that works for businesses and charities.

Looking for some help when it comes to life insurance? We’re here to help! Call us at (800) 521-7873 or email us at info@lifequote.com and let us give you the answers, guidance, and quotes you need!

Requirement for Third Party Life Insurance: Insurance Interest

To answer the question, “What is third party life insurance,” we need to talk about insurable interest.

Every state has its own specific rules that limit who can take out a life insurance policy on another person. To do this, there must be something called “insurable interest.” This means you need a financial reason for that coverage. That could be a shared household, where both parties contribute income for general expenses. Or it could be ex-spouses who don’t live together but contribute to the costs of raising their children.

Young man at home using his laptop to research the question, what is third party life insurance?

These rules don’t allow you to take out third party life insurance on, say, a boyfriend or girlfriend unless there are shared financial commitments or obligations. You also couldn’t take out life insurance on, for example, your boss. Although they may pay your salary, they are not responsible for your financial commitments (kids, mortgage, etc.), so there would be no insurable interest.

The Usual Situation: Insured + Owner + Payer Are the Same

In most cases, when you’re shopping for life insurance, you want to insure yourself in order to provide for your loved ones as your beneficiaries. You get a quote, you take a medical exam (unless you buy a non-med policy), you sign the insurance contract, and you start making payments. Easy, right?

Happy couple holding <a href= their toddler daughter" />

In this scenario, you are both the insured, the owner, and the payer, responsible for making the premium payments. The only other person involved is your beneficiary, who will get the income-tax-free death benefit when you pass away. There’s no question of insurable interest since you’re buying the policy to cover your own financial obligations.

If this is your situation, you’ll probably never ask the question, “What is third party life insurance.” Your experience will be much more straightforward, with less paperwork!

Third Party Life Insurance: Insured Is Not the Owner and/or Payer

But there are also plenty of reasons why you might be insured, but not own or even pay for your policy. That would make your situation a “third party life insurance” scenario.

Let’s look at what happens when you’re the insured, but not the owner.

Scenario #1: If you’re a star employee of a company, your employer may want to insure your life. Without you, the company would take a serious hit in terms of earning potential. That’s an insurable interest because they rely on the money you bring in to meet their financial obligations. In this case, the company could be the owner and payer and beneficiary, but you would be the insured. This is called “key person life insurance.”
Scenario #2: One spouse owns the policy covering the other spouse, who pays for the policy. Although most people choose to own their own policies, you could also name your spouse as the owner. That spouse could also be a beneficiary, or it could be one or more of your children. Learn more about beneficiary rules for spouses here.

Parents and young son sitting in the living room together.

Another situation is when you’re the insured, but an entity instead of a person owns the policy, usually for tax efficiency.

Scenario #1: Let’s say you’re a very wealthy person whose heirs might be liable for federal estate tax because you’re leaving them an amount that surpasses the estate tax threshold ($20 million, for example). If you remained the owner and the insured of your life insurance policy, your policy’s death benefit would be considered part of your estate and therefore subject to estate tax. To avoid burdening your heirs with this tax, you and your insurance agent set up an irrevocable life insurance trust as the owner of your policy. The trust would also be the beneficiary, and – as long as it’s been in place for three years – receive the death benefit tax-free. The trust’s officers would then be responsible for distributing that death benefit.

A third situation illustrates what happens when the insured is not the owner or the payer.

Scenario #1: Let’s say you have four children and no living spouse. You may decide to create a trust or LLC that would technically own your life insurance policy. You may name one of the children as that entity’s manager and make them responsible for paying the policy’s premiums. And it’s possible that you might want to select only grandchildren as your beneficiaries. In this case, your policy would have a different person or entity in each role as the owner, payer, insured, and beneficiary.