Clients often ask us about how their life insurance policies fit into their estate planning, and vice-versa. In this post we answer frequently asked questions on this subject. We will also tell you about specific traps you should avoid.
Note: This post addresses regular life insurance policies, NOT annuities with a death benefit. The latter are a different financial product and must be handled differently.
Uses For Life Insurance In Your Estate Planning
A life insurance policy involves three actors: the owner of the policy; the insured who may or may not be the owner; and the death beneficiary. There may be more than one death beneficiary, and the beneficiaries need not be equal beneficiaries. It is always wise to name contingent beneficiaries, too. For estate planning purposes, the main uses of a life insurance policy include:
- Replace the income of the decedent by providing money for the surviving spouse.
- Provide resources to protect a young family.
- Make sure that when you pass away, your family has ready cash to pay death-related expenses. These expenses may include court fees, taxes, funeral expenses, etc.
- Equalize inheritances to beneficiaries if your assets are not readily divisible. For example, if you have three children to whom you want to leave an equal inheritance, and your main asset is a house that only one child will inherit, you could purchase life insurance to provide each of the other two with a death benefit equal in value to the house.
- If you co-own a business, insurance on your co-owners’ lives can provide you with funds to purchase the deceased co-owners’ interest.
- Pay federal estate taxes, assuming there has been proper planning to use life insurance for this purpose. These arrangements are less common today than they were years ago when the federal estate tax exemptions were lower. However, it is expected that the exemption will decrease by about half in 2026. When that occurs, significantly more estates will be taxable.
Frequently Asked Questions
Do my death beneficiaries need to pay income tax on the money they receive?
No. When your death beneficiaries receive the proceeds, they have no personal income tax responsibility.
Is the death benefit subject to federal estate tax?
It depends. The death benefit is considered part of your estate.
The answer is YES if the death benefit pushes the value of your estate to taxable levels, currently $12.92 million.
The answer is NO if:
- the decedent was not the owner of the policy, or
- the death beneficiary is the spouse, assuming the spouse is a U.S. citizen, or
- the death beneficiary is a charity.
Because of the high value of the current federal estate tax exemption, for most decedents the policy proceeds will not produce a taxable estate. However, the exemption is scheduled to decrease to about $7 million in 2026. People with a very high net worth currently, and others who think they could be impacted by the upcoming reduction in the exemption, should consider creating an Irrevocable Life Insurance Trust. The “ILIT” can shelter life insurance proceeds from estate tax. It is a strategy that requires the trust to own the policy, which prevents you from borrowing from the policy or modifying it in any way. Find out more about the ILIT here. (Scroll down to the section labeled “Life Insurance Trust Can Provide Heirs Cash to Pay Estate Taxes.”)
Are the death benefits subject to the claims of creditors of the decedent?
No. Under Florida law, the death benefit is safe from the reach of the decedent’s creditors.
Is the benefit vulnerable to the claims of creditors of my death beneficiaries?
Yes. Once your death beneficiary receives the money, it is his/her asset and not shielded from creditors’ claims. If the person(s) you want to name as a death beneficiary has creditor issues, talk to your estate planning attorney about how to handle the situation. There are legal alternatives.
Do the proceeds from my insurance policy have to go through probate?
No, there is no need for probate if you have named death beneficiaries and they survive you. In that case the policy proceeds will go directly to them, with no need for the hassles and delays of probate. As a rule, you should NOT name your estate as the beneficiary, as this will require the proceeds to be probated.
What happens if my death beneficiary has passed away?
The funds then go to your contingent beneficiary. Your contingent beneficiary designations, like your primary death beneficiary designations, should be revisited from time to time and kept current.
What happens if there is no contingent beneficiary when I die and the primary beneficiary is also deceased?
If no contingent beneficiary exists, the insurance carrier will either:
- Make the proceeds payable to the insured’s estate, which as noted above must be probated, or
- Pay out pursuant to the default provision in the policy. Some default provisions distribute proceeds to the insured’s children in equal portions. This can be problematic under certain circumstances. By way of example: An estranged child you had no intention of leaving anything could end up inheriting the same amount from your policy as his siblings. A child with a drug or gambling problem could end up receiving a lump sum that he/she may mis-spend. Lastly, if one of your children is receiving federal benefits such as SSI or Medicaid, the death proceeds could push him/her over the asset cap and cut off benefits. Talk to your estate planning attorney about alternative methods for putting insurance proceeds into the hands of your children with these special circumstances.
Should I name my living trust as my beneficiary?
You may. You may specify who gets the proceeds in the living trust. Or you may leave it to the trust, and the proceeds will be distributed along with other assets, as the trust directs.
Who contacts the insurance carrier when I pass away?
Your beneficiary does, so make sure you tell the person that he/she is your death beneficiary. Also provide the beneficiary with the name of the insurance carrier and the policy number. The insurance company will require the beneficiary to furnish a death certificate and will ask for additional information. If everything is in order, the payout is usually made from within a couple of weeks to a couple of months.
Sometimes an insurance company does not know that the insured person has passed away. Although carriers are required to regularly check the Social Security Death Index, oversights do happen, and some names may not even appear in the index. Even if the carrier knows of the death, it may not be able to locate the beneficiary. As a result of these two circumstances, millions of dollars of benefits go unclaimed each year and end up in state coffers. Make sure your beneficiaries are aware of your policy.
Anything else I should know?
Yes. We urge anyone with a life insurance policy to regularly review the death beneficiary designations. Our attorneys see many estates in which the beneficiary designation was not properly updated after the death of the initial beneficiary, or after the insured was divorced from the initial beneficiary. Additional time and expense is always required to rectify the situation. You should do your due diligence now, periodically checking your beneficiary designations and updating them as necessary. Request written confirmation of the updated designations from the insurance carrier!
Call our office if you would like to talk with us about your estate plan and life insurance. Reach us at 561-625-1100.
