Overfunded Whole Life Insurance Risks IRS Reclassification of Family Loans

The tax-advantaged structure of an overfunded whole life insurance policy collapses if the IRS reclassifies informal family loans as taxable transfers. This risk occurs when a policyholder uses the policy's cash value to lend money to children or grandchildren to avoid gift taxes, but fails to document loan terms, interest rates, and repayment schedules. The IRS can determine that these funds were not loans but transfers, triggering taxes. This strategy relies on massively overfunding a policy that combines a death benefit with a savings component to pass wealth to future generations.