Payouts from life insurance policies rarely go through probate. If you’re worried about your property getting stuck in probate after you die, as long as your policy’s beneficiary designations are all squared away, you can cross life insurance off of your list of concerns.
However, if you might owe estate taxes, or if it’s possible that your beneficiaries might not survive you, then you may still have some planning to do to make sure that your life insurance policy doesn’t cause your estate extra expense.
Probate & Probate Avoidance
Probate is the court process of wrapping up the estate of a person who has died. Probate makes sure that a deceased person’s property goes to the right beneficiaries, and it also ensures that the estate pays all creditors. Probate can be time consuming and expensive, and for many estates it is an unnecessary hassle and expense because the needs of the estate are simple and easily resolved without the help of a court.
A handful of estate planning devices pass property to beneficiaries without probate. So if a person plans ahead by using living trusts, beneficiary designations, joint tenancy, and transfer-on-death deeds, their estates may not have to go through probate after their death. Additionally, most states have probate shortcuts for small estates, so even if a relatively small amount of property passes through a will, planning ahead can still save survivors time and money.
Life Insurance Policies Pay Directly to Named Beneficiaries
The proceeds from life insurance policies do not pass through probate as long as named beneficiaries are available to take the payout. When you buy a life insurance policy, you name beneficiaries who will receive the payout when you die. After your death, your named beneficiaries deal directly with the insurance company to receive the money. As a result, most life insurance policy payouts do not require involvement from probate, even if probate is required for other property in the deceased person’s estate.
Exceptions: When Life Insurance Payouts End Up in Probate
While life insurance proceeds usually avoid probate, there are some rare exceptions: If no beneficiaries are named or if none of the named beneficiaries are alive, then the life insurance will go into probate so that the court can determine the rightful recipient.
If the insurance money must go through probate, the insurance company issues a check made payable to the probate court. The probate court then deducts any probate fees and attorney fees from the money and distributes the balance according to the will of the person who died. If there is no will, then the money is distributed according to state law.
Other Life Insurance Issues
If estate planning and life insurance are on your mind, then you might consider a few additional insurance-related estate planning issues.
You Can't Change a Beneficiary Designation by Will
You cannot use your will to change who will get the proceeds from your insurance policy. The insurance contract is separate from your will, so even if you get married and change your will to say “I want everything to go to my wife Sheila,” if the named beneficiary of your life insurance policy is still your brother and he is alive and able to receive the payout, your brother will receive the check. For this reason, at every big life change—marriage, divorce, birth, death—you should review and update your beneficiary designations.
Life Insurance Policies Are Included in Your Taxable Estate
Most people don’t need to worry about estate taxes, but if you, you should know that the proceeds from a life insurance policy that you buy on your own life will be included in your taxable estate and will be subject to estate taxes.
- Example: Dominic’s estate is worth about $4.5 million. He knows that the federal estate tax exemption allows him to leave over $5 million without owing estate taxes, so he doesn’t worry about planning to avoid estate taxes. However, he fails to take into consideration the $1 million dollar life insurance policy he bought to give to his daughter. When he dies, the $1.25 million policy is included in his taxable estate, making it $5.75 million--larger than the estate tax exemption. His estate ends up owing estate taxes (at a 40% rate) on the overage.
You can avoid this problem by transferring the ownership of your life insurance policy—either to another person, or to a life insurance trust. However, this solution has pitfalls as well. If you’re concerned about estate taxes, see a tax professional or an estate planning attorney for help.
Questions for Your Attorney
You may want to ask your attorney the following questions:
- What is the best method of leaving life insurance money to my spouse and children?
- Should I set up a trust to be the beneficiary of my life insurance policy?
- How do I claim the proceeds of my dad’s life insurance policy if I can’t find any records for it?