Life Insurance Beneficiary: Estate As A Beneficiary?

Life insurance is an important financial tool that can provide financial security for your family and loved ones after you pass away. One of the most crucial steps when purchasing a life insurance policy is designating a beneficiary to receive the proceeds. While this may seem straightforward, it can be challenging, and mistakes can be costly and time-consuming for your beneficiaries. It is important to understand how life insurance factors into estate planning and how to best use your policy to achieve your goals.

Naming your estate as beneficiary

Naming your estate as the beneficiary of your life insurance policy can have unintended consequences. While it may be a simple decision to make, mistakes can be costly and time-consuming for your loved ones.

In the US state of Florida, for example, naming your estate as the beneficiary subjects the benefits to the claims of creditors. The proceeds become an asset of the probate estate, which can take months to be distributed to your beneficiaries. The proceeds are then subject to all the costs associated with settling an estate, including taxes, administrative costs, attorney fees, and executor fees.

By contrast, naming an individual, charity, or trust as a beneficiary on your life insurance policy shortens the process of releasing the proceeds. This is done by completing forms and presenting the death certificate to the insurance company. The insurance company will then distribute the proceeds to the beneficiary or beneficiaries based on the distribution you designated. This leaves little work for your beneficiaries in collecting the proceeds and reduces the time it takes for them to receive the funds.

Under state law, life insurance proceeds payable to an individual or, in some cases, a trust, are exempt from creditor claims. By leaving the benefits of your life insurance policy to your estate, you open up the opportunity for creditors to collect from those proceeds to satisfy their claims. That means your life insurance proceeds could be used to pay off any outstanding debts you may have at the time of your death before they are distributed to your beneficiaries.

A better alternative to naming your estate as the beneficiary is to name a trust. Proceeds distributed to a carefully constructed trust will be shielded from the claims of creditors and will not be included in the probate estate. Naming the trust as the beneficiary also eliminates additional steps and time involved in collecting the proceeds and ensures that the distribution of proceeds will not be postponed due to satisfying debts, expenses, or creditors' claims.

Avoiding probate

Properly Designate Beneficiaries

• Ensure your beneficiary is alive. One common mistake is failing to update the beneficiary designation after the death of a spouse.
• Your beneficiary must be over the age of 18. If the beneficiary is a minor, the court may appoint a guardian to manage the benefits until they come of age, unless a trust is created for the minor to receive the benefits.
• You cannot change a beneficiary designation through a will. The insurance contract is separate from your will, so even if you change your will, the beneficiary designation takes precedence.
• Designate a contingent or alternate beneficiary. This provides protection and reduces the possibility of a policy having to go through probate if the intended beneficiary is unavailable due to death or cannot be reached.
• Update your policies after major life events, such as divorce, marriage, or the death of a loved one.

Use a Trust as a Beneficiary

Using a trust as a life insurance beneficiary gives you control over the payout timing and keeps the proceeds out of the estate. There are two main ways to do this:

• Name a trust as the beneficiary of the life insurance contract. The death benefit is paid to the trust, and the trust document determines if and when any money is distributed to the beneficiaries.
• Use an irrevocable life insurance trust (ILIT). The trust owns the life insurance policy and receives the death benefit, keeping the proceeds out of your estate.

Estate tax liability

Naming your estate as the beneficiary of your life insurance policy is possible but not advisable. This is because doing so removes the contractual advantage of naming a real person as the beneficiary and subjects the financial product to the probate process. Leaving items to your estate also increases the estate's value, which could subject your heirs to exceptionally high estate taxes.

If you name your estate as the beneficiary of your life insurance policy, the person or people inheriting your estate may have to pay estate taxes. This is because the value of life insurance proceeds insuring your life is included in your gross estate if the proceeds are payable to your estate, either directly or indirectly.

In the US, the federal estate tax applies to large estates—those worth at least $13.99 million as of 2025. Assets above this level may result in fairly steep taxes. For example, if the death benefit payout is $500,000 but earns 10% interest for one year before being paid out, the beneficiary will owe taxes on the $50,000 growth.

Some states in the US also impose estate taxes, and while most do not, those that do have relatively low thresholds compared to the federal estate tax. For example, Oregon taxes estates worth $1 million or more.

It is important to note that federal taxes won't be due on many estates. The basic exclusion amount for an estate for a decedent who passed away in 2022 is $12.06 million, and the exclusion amount for 2023 is $12.92 million. The top-tier tax rate is capped at 40%.

To avoid paying any taxes on life insurance proceeds, you can transfer ownership of the policy to another person or entity. This can be done by creating an irrevocable life insurance trust (ILIT). By transferring ownership of the policy to an ILIT, you remove it from your estate, and the proceeds are not included as part of your estate.

Choosing beneficiaries

First, it is generally advisable to avoid naming your estate as the beneficiary of your life insurance policy. While it may seem like a straightforward decision, this can lead to unintended consequences. If your estate is the beneficiary, the life insurance proceeds become part of the probate estate, subject to claims by creditors and the associated costs, including taxes, administrative expenses, attorney fees, and executor fees. This can result in delays in distributing the proceeds to your beneficiaries.

Instead, consider naming specific individuals, charities, or trusts as beneficiaries. By doing so, you can significantly streamline the process of releasing the proceeds, as it typically involves completing forms and presenting the death certificate to the insurance company. This approach ensures your beneficiaries receive the proceeds promptly and with minimal hassle.

When selecting beneficiaries, it is crucial to keep your overall estate plan in mind. If you have a trust, it is generally recommended that the trust owns your life insurance policy rather than being the beneficiary. This arrangement helps keep the life insurance proceeds out of your estate, potentially reducing probate costs and taxes. It also shields the proceeds from creditors' claims.

Additionally, consider the number of beneficiaries you designate. Listing only two individuals on the contract, such as a spouse and a child, can help avoid potential tax issues. According to Tom Doll, a senior wealth and insurance strategist, the ideal arrangement is to have your spouse as the owner and beneficiary of the policy, with you as the insured. This strategy helps ensure that the insurance proceeds are not deemed a gift to your children, which could trigger taxation.

Finally, be mindful of life changes, such as divorce or the death of a family member, and regularly review your beneficiary designations. It is essential to update your designations to reflect your current wishes and prevent unintended consequences, such as the proceeds going to the wrong people or an ex-spouse.

In conclusion, choosing beneficiaries for your life insurance policy is a vital aspect of estate planning. By selecting the right beneficiaries and considering the ownership structure, you can maximize the impact of your assets, minimize taxes and probate costs, and ensure your wishes are carried out effectively.

Using a trust

A revocable trust is a more popular option for young families as it offers more flexibility. It allows the trust owner to make changes to the trust and take distributions from it until their death. After the trust owner passes away, the assets are transferred to the trust's beneficiaries. Revocable trusts are a good option for those who want to protect their life insurance benefits and reserve them for the cost of caring for their children or as a future inheritance for their minor children.

On the other hand, an irrevocable trust cannot be modified once it is set up. This includes changes to the beneficiaries, even in cases of divorce or a change in preference. By having an irrevocable trust own the policy, the proceeds of the death benefit payout will not be included as part of your taxable estate, which can be taxed as high as 40%. While revocable trusts do not qualify for this exclusion, they can help you avoid probate and control the cash flow distributed to your children.

It is important to note that the process of setting up a trust can be complicated and may involve legal and tax implications. The costs of setting up a trust include expenses related to setting up deeds, transferring ownership, and legal fees. Additionally, a will is required to set up a trust. Consulting with an estate planning attorney and a financial planner can help determine if using a trust as a life insurance beneficiary is the best option for your specific situation.

Frequently asked questions