Life insurance is not an estate asset. Instead of transferring to the estate and sitting in probate, a life insurance policy is paid directly from the insurance company to the beneficiary listed in the agreement.
There are a few exceptions to this, but overall it is important to treat life insurance as an asset independent of the estate. Continue reading to explore what separates life insurance payouts from your legal estate and how these differences can be used to increase your theoretical estate potential.
A life insurance policy is a contract that connects:
The policy owner can be the same as the insured, but this is not a requirement. Corporations can also take out insurance policies on key members and double as the beneficiary.
Due to the terms of this contract, when the insured dies the insurance company is obligated to pay a sum directly to the beneficiary. The money only ever belongs to the insurance company or the beneficiary. These funds do not pass through the insured, and therefore they are not part of the estate of the insured.
The control or responsibility of a life insurance policy is split between different parties at different points in its life.
Before the death of the insured, the policy owner has the right and the responsibility to update the policy as needed. This involves adjusting policy coverage, accessing any cash value, and adjusting the beneficiary as needed. The policy owner can change the beneficiary until the moment of death by filing the proper documents with the insurance company.
After the life insurance policy is triggered the policyholder cannot adjust coverage or any other details. From this point on it is the responsibility of the beneficiary to handle any issues regarding the completion of the contract.
If a life insurance policy were an estate asset then the power would transfer to the estate trustee, but this would only occur if the trustee were the same as the beneficiary.
Life insurance can be considered an estate asset if there is no beneficiary to pay out to or the policy is marked to pay to the estate.
While the second option is a choice, the first happens most often when a beneficiary dies before the insured. If the beneficiary is not updated in these circumstances, then the insurance company is instructed to pay the value of the policy to the estate.
From that point, the estate manager will handle the distribution of the funds, and it is likely to be split between any beneficiaries for the estate.
Because life insurance does not pass through the estate there are cases when funds are directed to a party other than the intended. An estate manager might be able to rectify this issue if the funds were filtered through as estate assets, but an insurance company is obligated to pay the sum directly to the beneficiary.
You see this issue come up most often in the case of divorce. The policyholder, usually also the insured, fails to update the policy to list their heir or new spouse as the beneficiary, and the ex-spouse receives the amount.
There is no way to rectify this issue once the insured passes, so it is essential to keep the beneficiary updated with major life events like divorce, remarriage, and the death of the beneficiary.
An insurance company can also refuse to pay the beneficiary. Whether the refusal is warranted or not, the beneficiary would need to pursue the case in court.
While life insurance is not considered an estate asset for legal reasons, it can still expand on the value of the estate. Policies can be used to:
These strategies capitalize on the ability of a policy to transfer without getting stuck in probate, and they maximize the potential of a policyholder to leave behind a legacy.
No amount of planning can protect loved ones from dealing with the tasks necessary after death, but a life insurance policy can alleviate the financial burden. Because the policy funds are not subjected to a probationary period like assets of the estate they can be used to:
Without immediate access to these funds, family members can enter a period of struggling to meet the tax burden put on the estate. This could result in heirs using personal funds to cover this burden or even selling off items to raise money.
A life insurance policy is a popular way to facilitate the transfer of business shares. Unlike aspects of the estate, a corporation that has taken out the proper life insurance policy can use funds to buy out the shares of the deceased party and continue with the business plan.
In this case, the policy needs to define what the funds are used for.
A life insurance policy is also an easy way to increase the amount paid out to heirs. By listing a beneficiary of the policy you can guarantee that they receive a specific amount instead of leaving them at the mercy of the actual value of estate assets.
Beneficiaries are not required to pay tax on life insurance payouts. When compared to the taxes imposed on estate assets, this proves to be an effective way to pass funds to an heir without racking up tax fees.
Life insurance may not be an estate asset, but it provides a smart way for beneficiaries to access funds after death. Contact Sim Gakhar for help using life insurance as a way to maximize your estate potential.
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