Life Insurance Probate: What's The Verdict?

Life insurance is a financial safety net for those we leave behind. But what happens when that fateful day arrives? Does the life insurance payout form part of the deceased's estate, and is it subject to probate?

In most cases, life insurance proceeds are paid directly to the beneficiaries named in the policy and therefore never come into or out of the deceased's estate. However, there are exceptions. If there is no named beneficiary or the beneficiary has died, the policy may have to go through probate.

Does a life insurance payout need to go through probate?

Life insurance is designed to provide financial security to your family or loved ones when you die. But does a life insurance payout need to go through probate?

In most cases, a life insurance payout does not need to go through probate. This is because the policy designates a beneficiary, and the death benefits are paid directly to this beneficiary, not the estate. However, there are exceptions to this.

If there is no beneficiary named on the policy, or the beneficiary has died, then the life insurance payout will need to go through probate. In these cases, the payout will be treated as part of the deceased's estate and will be distributed according to the will or per state laws.

How to avoid probate

The best way to avoid probate is to ensure that your life insurance policy is up to date and has named both a primary and a contingent beneficiary. It is also important to remember to update your policy after major life events such as a divorce, marriage, or death.

How to avoid probate with life insurance

Life insurance is generally not subject to probate as the money in a life insurance policy is not considered part of the deceased's estate. Instead, the insurance company holds the policy amount in trust for the beneficiaries, and the funds go straight to them when the policyholder passes away. However, there are certain scenarios where life insurance may be subject to probate, such as when the beneficiary predeceases the policyholder or when the policy is payable to the insured's estate. In these cases, the life insurance proceeds will be paid out to the estate, and probate will be required.

To avoid probate with life insurance, it is important to keep your beneficiary designations up to date. Here are some guidelines to help you do that:

• Alive beneficiary: Ensure that the beneficiary is alive. One common mistake is failing to update the beneficiary designation after the death of a spouse. If the beneficiary is deceased, the proceeds must go through probate.
• Adult beneficiary: The beneficiary must be over the age of 18. If the beneficiary is a minor, the court may appoint a guardian, requiring probate. To avoid this, you can name a trust created for the minor as the beneficiary.
• Contingent beneficiary: List a second option as a contingent or alternate beneficiary. This reduces the possibility of the policy going through probate due to the primary beneficiary's unavailability.
• Update after major life events: Review and update beneficiary designations after major life events such as divorce, marriage, or the death of a loved one. This helps to prevent unintended consequences, such as the proceeds going to an ex-spouse.

By properly designating beneficiaries and keeping your life insurance policy up to date, you can help ensure that the proceeds go directly to your intended beneficiaries without the need for probate.

Life insurance in a trust

A life insurance trust is a trust designed to be the owner or beneficiary of your life insurance policy. There are two types of life insurance trusts: irrevocable trusts and revocable trusts.

Irrevocable Life Insurance Trusts (ILITs)

ILITs are created to own and control a term or permanent life insurance policy during the insured's lifetime. They are also used to manage and distribute the proceeds that are paid out upon the insured's death, according to the insured's wishes.

ILITs are a powerful tool for minimising estate taxes, avoiding gift taxes, and protecting government benefits. They are especially useful for those with a large estate who want to reduce their tax liability. Since the proceeds from the death benefit are excluded from the grantor's estate, multiple generations of the family may benefit from the trust's assets free of estate and generation-skipping transfer (GST) tax.

The primary downside of an irrevocable trust is that it cannot be altered or undone once it is created.

Revocable Trusts

Revocable trusts offer more flexibility and control than irrevocable trusts. They can be amended or revoked at any time, and taxes for the assets in the trust can be filed under the grantor's social security number.

If the grantor becomes incapacitated, a successor trustee will be able to continue administering the life insurance policy on their behalf.

Benefits of Life Insurance Trusts

Life insurance trusts provide several benefits, including:

• Management and control of assets: The trust provides for the management and distribution of the life insurance funds according to the grantor's wishes.
• Protection from creditors: Proceeds from life insurance are generally protected under state law, and a life insurance trust can help protect beneficiaries from their creditors or any unforeseen divorce.
• Reduced federal estate tax: ILITs can be used to reduce estate tax liability, especially for those with a large estate.
• Maintaining or qualifying for governmental benefits: A life insurance trust can be set up to protect the interests of a beneficiary who is disabled and receiving governmental assistance, such as Medicaid.
• Avoiding guardianship for minors: In some states, if a minor receives a large sum of money, a guardianship must be established. A life insurance trust can help avoid this by administering the proceeds for the benefit of the minor without court intervention.
• Liquidity: A life insurance policy allows beneficiaries to access funds immediately, which can be especially useful if there is a delay in selling or receiving benefits from other assets in the estate.

What happens if there is no beneficiary?

If there is no beneficiary listed on a life insurance policy, the insurance company is still required by contract and law to pay out the benefits. In this case, the benefits will be paid to the estate of the deceased. The "estate" includes all the assets possessed by the deceased at the time of their death, such as cash, bank accounts, personal items, real estate, investment accounts, as well as debts and liabilities.

Once the death benefits are paid to the estate, they become part of the probate process. The funds, along with other assets in the estate, will be used to pay off any debts, including taxes and funeral costs. After debts are paid, the remaining funds are distributed as per the will of the deceased. If there is no will, the remaining funds are paid to the next of kin as defined by state laws.

It is important to note that if a life insurance policy has no living beneficiaries or no beneficiaries are named, the death benefit is usually paid to the policy owner's estate, and the process can be lengthy, causing delays in receiving funds for the loved ones of the deceased.

How does probate work?

Probate is the legal process of proving that a will is valid. If there is no will, the estate may still have to go through probate. In this case, the court appoints an administrator and directs them on the payment of debts and distribution of assets as determined by state law.

The basic probate steps are as follows:

• An individual or entity (often named in the will) petitions the probate court to become the legal representative of the estate.
• The legal representative (executor or administrator) notifies heirs and creditors of the death.
• The legal representative takes possession of the deceased individual’s assets.
• The legal representative pays funeral expenses, taxes, and debts.
• The legal representative transfers remaining assets to the heirs.
• The legal representative notifies the court of its actions and requests that the estate be closed.

The need for probate typically increases with the size and complexity of the estate. Depending on the situation, probate may be necessary to transfer property or title, or determine the heirs.

There are two types of probate: voluntary and mandatory. Voluntary probate is when all interested parties agree that the will is valid. This can be done without going to court. Mandatory probate is when one or more interested parties do not agree that the will is valid, or when the validity of the will is in question. In this case, a judge in court must settle the matter.

In terms of life insurance, a life insurance payout can be a significant financial resource for families dealing with a loss. Whether or not a life insurance policy payout passes through probate depends on factors such as whether the policy has any named beneficiaries, whether these people are alive, and whether the policyholder intended the payout to cover debts owed by their estate.

If the beneficiaries are alive, the policy's payout is not considered part of the estate and will not be probated. Instead, the payout will go directly to the living beneficiaries. However, if the beneficiaries have passed away, the payout will become part of the estate and enter probate with the rest of the assets and property.

Frequently asked questions