Life Insurance And Probate: What's The Connection?

Life insurance is a financial safety net for families in the event of a bereavement. But does it have to go through probate first? The answer is: it depends. Probate is a legal process where a court approves a will and appoints an executor to carry out the payment of debts and distribution of assets from an estate. If there is no will, the court appoints an administrator. In general, life insurance proceeds do not go through probate because the money in a policy is not part of the estate and never becomes an asset of the deceased. Instead, the insurance company holds the policy amount in trust for the beneficiaries. However, there are exceptions, such as when the beneficiary of a policy dies before the insured or when the policy is payable to the insured's estate. In these cases, the life insurance proceeds may be subject to probate.

Life insurance policies and their beneficiaries

Life insurance policies are often taken out to cover the value of a mortgage, so that in the event of the policyholder's death, their loved ones are not burdened with the debt. In such cases, the policyholder may name their spouse or partner as the beneficiary, but it is important to keep the details of beneficiaries up to date. For example, if a husband and wife list each other as beneficiaries and the husband dies, the wife should update her policy so that it doesn't list her deceased husband as the beneficiary. Otherwise, when she dies, the life insurance proceeds will have to go through probate.

It is also important to note that if all the beneficiaries of a life insurance policy have died before the policyholder, the money from the payout will become part of the policyholder's estate and will enter probate. The proceeds will then be used to pay off any creditors.

To avoid probate, it is essential to properly designate beneficiaries. A beneficiary must be alive and over the age of 18. If the beneficiary is a minor, the court may appoint a guardian, which would require probate. To avoid this, a trust can be created for the minor, and the trust can be named as the beneficiary of the policy.

It is also crucial to periodically check and update beneficiary designations after significant life events such as divorce, marriage, or the death of a loved one. In some states, divorce automatically revokes the ex-spouse's status as a designated beneficiary on a life insurance policy. However, if the policy owner does not update the designation, the policy will be left without a beneficiary, and the proceeds may have to go through probate.

When a life insurance policy has to go through probate, it can be used to pay any remaining debts or taxes before the remainder is distributed to the intended beneficiary. On the other hand, funds in a life insurance policy that flows directly to a designated beneficiary are not readily available to estate creditors.

To claim a life insurance benefit, the designated beneficiary must contact the insurance company and provide a certified copy of the death certificate. Once the claim is approved, the insurance company will issue the payment directly to the beneficiary.

Probate and debt

When someone dies, their assets—financial accounts, possessions, and real estate—become their "estate". The estate is generally what creditors go after to try collecting on the debt.

The process of paying off all the debt and then distributing any remaining assets from the estate to heirs is called probate. Each state has its own laws governing how long creditors have to make a claim against the estate during that time. In some places, it's a few months, while in others, the process can last a couple of years.

If there isn't enough money to pay outstanding debts, the estate has to pay off any outstanding debts in a set order before anything is given to people named in the will, or until the money runs out. The debts are paid in the following order:

• Secured debts, such as mortgage repayments
• Priority debts, such as Income Tax and Council Tax
• Unsecured debts, including utility bills and credit cards

If there is insurance, check the terms of the policy for what can be claimed. If there is no insurance, contact the creditors to make arrangements to pay off the debts.

If there isn't enough money in the estate to pay off all the debts, the most important are paid off first. If there are assets, such as a car or house, which could go towards paying off the debts if sold, it's an option worth considering.

If there are more debts than the estate can pay back, this is called an 'insolvent estate'. In this case, the executor or administrator of the estate will need special permission, called 'probate' or 'letters of administration', to be able to deal with the person's affairs, including paying off their debts.

It's important to note that not all assets are counted as part of a person's estate for probate purposes. For example, life insurance policies and qualified retirement accounts (e.g. a 401(k) or individual retirement account) go directly to the person named as the beneficiary and are not subject to probate. Additionally, assets placed in certain types of trusts also pass on outside of probate, as does jointly owned property (e.g. a house) as long as it is titled properly.

Locating a policy

Locating a life insurance policy can be challenging, especially if the policyholder has not kept proper records. Here are some steps you can take to locate a missing life insurance policy:

• Check the decedent's records: Look through their documents, including bank statements, cancelled cheques, income tax records, and safety deposit box. These may provide clues about the insurance company or policy details.
• Contact their previous employers: The deceased may have had an employer-provided group life policy, so it's worth reaching out to their past employers to inquire about any existing policies.
• Review their insurance agents: Get in touch with the decedent's auto or home insurance agents, as they may have purchased life insurance through them or as part of a bundle.
• Utilise the National Association of Insurance Commissioners (NAIC) Life Insurance Policy Locator: This free service helps consumers locate benefits from life insurance policies purchased in the United States. The insurance companies will search their records and contact you if they find a policy in the name of the deceased, provided you are the designated beneficiary or authorised legal representative. However, you must conduct a diligent search of the decedent's records before using this service.
• Check with the State Controller's Office: Life insurance companies are required to report and deliver property to the State Controller's Office after a certain period of inactivity, generally three years or more. You can use their Life Insurance Settlement Property Search engine or give them a call to inquire about any policies in the decedent's name.
• Call the Consumer Hotline: If you find a life insurance policy for a deceased relative but cannot locate the company, you can call the Consumer Hotline for assistance in obtaining the company's contact information.

It is important to be thorough in your search, as a missing life insurance policy can have significant financial implications for the beneficiaries.

Claiming a policy

Claiming a life insurance policy is a relatively straightforward process. Here are the steps you need to take:

Step 1: Submit Proof of Death

Provide at least one document as proof of death, such as the death certificate, a funeral director's statement, or a funeral service program. If the death benefit payment is high, the insurance company may require two separate documents. In some cases, the insurance company may also request an attending physician's statement to certify the cause of death and verify the medical information used to underwrite the policy. Make sure to check the specific requirements of the insurance company, as most do not accept a death certificate with the cause of death listed as "pending". If the death occurred in a foreign country, you may need to provide a valid death certificate from that country, translated into English or the main business language of the insurance carrier.

Step 2: Submit the Policy Contract

Submit the original policy document, if available. This helps speed up the process by allowing the insurance company to cross-check the information. If you have lost or misplaced the original policy, contact the company to retrieve a digital copy.

Step 3: Fill Out the Death Claim Paperwork

Provide all relevant information pertaining to your claim, including the relationship of the beneficiary or claimant to the insured, funeral home information, and any other pertinent details about the death.

Step 4: Specify Payout Method

As a beneficiary, you can usually choose between receiving the death benefit as a lump-sum payment or as an annuity. With the annuity option, the death benefit amount is invested and paid out as a yearly payment, either for life or for a predetermined number of years, depending on the policy. Not all policies offer the annuity option, so be sure to check.

Step 5: Wait for Claim Processing

The insurance company will process the claim and fact-check the information provided. This can take anywhere from a few days to 30-60 business days, or even longer if there is an investigation or other issues with the claim.

Step 6: Receive the Payout

Once the processing is complete, the beneficiary will receive the benefit in the requested payment method (lump sum or annuity).

Life insurance and estate taxes

Firstly, it's important to know that life insurance proceeds are generally not considered part of the beneficiary's gross income, so they aren't subject to income tax. However, there are certain situations where a death benefit can be taxed. For example, if the payout is structured as multiple payments, those payments may be taxable. If the policyholder has withdrawn money or taken out a loan against the policy, any amount withdrawn or loaned above the total of the premiums paid may be taxable.

In most cases, life insurance proceeds do not go through probate because the money in a life insurance policy is not part of the estate of the deceased and never becomes an asset of the policyholder. Instead, the insurance company holds the policy amount in trust for the beneficiaries, only releasing the funds upon the policyholder's death. However, there are two scenarios in which life insurance may go through probate: if the beneficiary predeceases the policyholder and there is no contingent beneficiary, or if the life insurance is payable to the insured's estate.

Life insurance proceeds are also not usually part of a deceased person's estate, so they are typically exempt from inheritance tax. However, if the payout is large enough, it may be subject to estate tax. According to the IRS, if life insurance proceeds are included as part of the deceased's estate and, together with the rest of the estate, exceed the federal estate tax threshold of $12.92 million as of 2023, estate taxes must be paid on the proceeds over the allowed limit. This threshold is set to increase to $13.16 million in 2024.

To avoid estate taxes, some people choose to transfer ownership of their life insurance policy to another person or entity, such as an irrevocable life insurance trust (ILIT). However, it's important to be aware of the three-year rule, which states that gifts of life insurance policies made within three years of death are still subject to federal estate tax. So, if the original owner dies within three years of transferring ownership, the proceeds will be taxed as though they were still part of the estate.

Frequently asked questions