Life insurance is not designed to go through an estate, but it will if there is not a viable beneficiary to pay out a death benefit to.
Continue reading to understand important terms relating estates to life insurance, why life insurance is not generally considered an estate asset, and what happens in the exception to this situation.
While estates and life insurance can operate in the same timeline, understanding the parts of each will help you understand how life insurance may or may not go through an estate.
Explanations are listed for terms and processes such as:
A life insurance policy is a contract between a policyholder and the insurance company stating that when the insured died the company pays a lump sum of tax-free money to a named beneficiary.
The policyholder can be the same as the insured or the beneficiary, but they are responsible for the premiums paid into the policy.
Term life insurance policies keep this contract active for a certain period, and they have lower premiums to reflect a more straightforward agreement.
Permanent life insurance policies last as long as the premiums are paid. They cost more, especially at the start of the policy, but also provide a cash value that grows in value over time.
The estate is defined as everything owned by the deceased upon their death, including:
The value of the estate is calculated by determining the value of the assets and subtracting the liabilities. Anything designated to pass on to another person must go through the probate process with the rest of the estate.
A will is a written document that provides clear instructions for how the deceased wants their affairs handled after their death. This can include:
An executor is either chosen by the deceased or assigned by the court to carry out the will. A will needs to be verified to stand up for processing, and they do not hold power over other designations such as beneficiaries of certain accounts.
Probate is a necessary legal process during which the will of the deceased is authenticated. Things that happen during this time include:
The probate period continues without a will, but assets are distributed in accordance with provincial laws in this case.
The executor is the individual chosen to arrange the distribution of the assets of an estate, whether they are named by the deceased or chosen by the court.
The executor can be paid a fee for carrying out their duties, but they maintain the responsibility to act under the terms of the will, the law, and the interest of the estate.
In most cases, life insurance is not considered an asset of a deceased person’s estate.
If you look back at the process for a life insurance policy you should note that the proceeds from the policy never belong to the insured, regardless of whether they are the policyholder or not.
During the life of the insured the policyholder owns the policy, and they have access to the cash value (in permanent policies), but the death benefit never belongs to them.
The amount of the death benefit belongs to the insurance company until it is paid directly to the beneficiary. It does not once move through the ownership of the insured, and there are only a few situations where it can be considered an asset and move through the estate.
While life insurance is intended to be paid to the beneficiary, insurance companies must have a contingency plan for situations where a beneficiary is not named or is not around to release the proceeds to.
This happens most often when a person cannot name a beneficiary or they fail to update their policy after the beneficiary dies before them.
In these situations, the life insurance policy has nowhere else to go. It moves through the estate in the same way as other assets.
Probate does a few things to a life insurance policy.
It incurs taxes on the amount of the policy. Depending on the size of the policy, taxes on the estate can even increase. This means that more will be taken out of the original assets than would be without the addition of the policy.
Probate also holds the funds until the process is finished. This means that during this time, the family cannot access the funds to cover end-of-life expenses, living expenses, or pay off fees affecting other assets.
By keeping the insurance policy from entering the estate, you can forego the probate process and lead to instant, untaxed payouts.
The only way to ensure that life insurance does not go through an estate is to maintain a valid beneficiary on the policy. Start by naming a beneficiary, and then keep this updated through major life changes.
Certain policies may also allow you to designate a contingent beneficiary. This will allow you to have a backup plan if you fail to update the beneficiary or the original beneficiary dies at the same time as the insured.
If you are worried that your life insurance policy may go through your estate, want another set of eyes to look over your policy, or need help setting one up then contact Sim Gakhar. A professional insurance agent is your best option for peace of mind when planning your estate.
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