A life insurance policy is there for your loved ones in your passing. Your family is already going through tough times and the last thing you want is to leave more tasks. Conveniently, life insurance generally does not have to go through probate. This saves not only expenses, but keeps your life insurance away from creditors and ensures a quick and easy passing of assets.
Life insurance typically passes outside of the probate process. However, it is important to set up your life insurance correctly and have the rest of your affairs in order.
We will explain about probate, life insurance, and how to proceed to ensure a quick and painless passing of your death benefit.
Key Takeaways:
- Life insurance payouts transfer directly from a deceased to the beneficiary. Therefore, they are generally kept outside of probate.
- There are times when life insurance does go through probate. This is typically when there is no named beneficiary or the beneficiaries have died / can’t be located.
- Probate is an expensive and long process that can takes months or years to finish. Most people try to keep as many assets outside of probate as possible.
[Note – Nothing in this blog is legal advice, please consult your own counsel about your individual situation.]
Life Insurance Proceeds Are Typically Not ‘Probate Assets’
Life insurance is seen as a special type of asset. This is due to life insurance proceeds transferring automatically to the named beneficiaries when the insured dies.
Upon the death of a policyholder, the beneficiary should contact the insurance company. There will be insurance claim forms to fill out and you will typically need to provide a certified copy of the insured’s death certificate. Although many insurance companies are attempting to streamline this process.
“If the beneficiary of your life insurance policy is alive upon your death, the payout is not considered part of your estate and will avoid probate”
-Professor B.T. Effer
Generally, a beneficiary does not have to notify the courts or open a probate proceeding.
Only ‘probate assets’ become part of an estate that ends up in the courts. In probate, the deceased’s assets are distributed by a court. Probate assets are those that don’t automatically transfer upon death.
When Does Life Insurance Go Through Probate?
Life insurance will typically only become a probate asset if it can not automatically transfer. This can be due to:
- No beneficiary being designated
- Designated beneficiary being deceased & no contingent beneficiary
- Beneficiaries being unable to be located
For example, if there is no living named beneficiary on file, then the life insurance may end up in probate. Most insurance allows you to name beneficiaries and contingent beneficiaries for back-up.
When life insurance ends up in probate court, they will pass according to the deceased’s last will and testament, if there was one. If there is no will, the court will determine how to distribute assets.
Lastly, if the beneficiary is a minor, the probate court will appoint a guardian. Even though the insurance assets are outside the jurisdiction of the probate court, the assignment of the guardian is done by the court.
This is why setting up a trust with a named adult as the trustee can be a huge help. The life insurance assets will go to the trust and the trustee is legally obligated to disburse them per the directions you leave.
What is a ‘Per Stirpes’ Beneficiary Designation?
A ‘per stirpes’ beneficiary designation will pass the asset to the beneficiary’s heirs if the beneficiary dies. Some life insurance policies allow for a ‘per stirpes’ beneficiary designation.
‘Per stirpes’ designations can provide extra protection in keeping life insurance out of probate, when available.
What Is Probate?
For those unfamiliar, the probate process is where a court oversees the passing of an estate. This typically involves the court:
- Approving a will
- Appointing an executor to carry out the distribution of assets and payments of debt, if a will and executor is named. Otherwise,
- Appointing an administrator and directing them on how to distribute assets and pay debts based on state law.
What Are The Steps To The Probate Process?
Upon a death, the basic steps to the probate process are:
- Someone (usually named in the will) petitions the court to become the legal representative of the estate
- Then the legal representative (either the executor or administrator) notifies creditors and heirs of the death
- All assets of the deceased become the possession of the legal representative
- Funeral expenses, taxes, and debts are paid by the legal representative
- Any remaining assets are transferred to the heirs by the legal representative based on the deceased’s will or the court’s direction
- The legal representative notifies the court once the actions are complete and closes the estate
In general, probate is costly and involves a lot of administrative work. It can take months to years to liquidate and disburse all the assets.
For this reason, most people try to avoid probate for their loved ones as much as possible. This is done by removing assets from the court’s jurisdiction. The more assets that transfer automatically to beneficiaries, the less work needs to be done in the probate process.
Other Benefits of Using Life Insurance To Pass Assets Outside of Probate
Life insurance payouts will happen much quicker than assets that go through the probate process. But that isn’t the only benefit of using life insurance to avoid court.
If you die in debt, and if your estate is not large enough to cover the debt, life insurance assets aren’t collectible by creditors after your death. Again, upon the death of the insured, the payout passes directly to beneficiaries. This means naming a loved one as the beneficiary of your policy you ensure they will have the access to at least those funds.
However, if you don’t designate a beneficiary or if no named beneficiaries are alive, your life insurance does end in probate. And once in probate your creditors can make a claim to the funds.
This is why it is imperative to ensure you review and update your beneficiaries on your policy.
Life Insurance and Estate Taxes
Unfortunately, the cash value of a life insurance policy is generally included in the estate for state and federal estate taxes.
The current federal estate tax exemption is $12,060,000 in 2022. Therefore, most estates will fall below that threshold. However, each state has its own estate tax laws that may be lower.
The Final Word
Life insurance is a vital part of your personal financial portfolio. It makes up an important part of the protection bucket of the 5 pillars of personal finance. Additionally, life insurance helps you with peace of mind that your loved ones are well protected in your death.
Not only that, but life insurance can help you keep assets out of probate and ensure a seamless passing of assets to the beneficiary you want.
It is crucial to work with a professional to properly set up your finances for after you pass. And it is a good habit to review your life insurance beneficiaries at least annually to ensure all your policies are correct and up-to-date.
Frequently Asked Questions (FAQs):
Generally no, life insurance does not go through probate. Since there is a named beneficiary and the benefit automatically passes to the beneficiary, there is no need for probate.
However, if there is no beneficiary, or if all beneficiaries and contingent beneficiaries already passed, then life insurance may wind up in probate.
A ‘per stirpes’ beneficiary designation automatically passes assets to a beneficiary’s heirs if the beneficiary has also passed. It is added protection to keep life insurance out of probate. However, not all policies give the option.
In general, life insurance is not part of probate and passes directly to the beneficiary. However, there are times when your life insurance payout may end up in probate.
1) If you don’t designate a beneficiary
2) If all named beneficiaries already died with no contingent beneficiary named, or
3) If the beneficiary can’t be located
It is important to review your beneficiary information to ensure it is up to date and accurate.
The probate process is where a court oversees the passing of an estate. This typically involves the court:
1) Approving a will
2) Appointing an executor to carry out the distribution of assets and payments of debt, if a will and executor is named. Otherwise,
3) Appointing an administrator and directing them on how to distribute assets and pay debts based on state law.
It can take months or years for the probate process to finish. Additionally, it can be very expensive and involve a lot of administrative work. Most people try to keep as many assets outside the jurisdiction of probate as possible.
Unfortunately, the cash value of a life insurance policy is generally included in the estate for state and federal estate taxes.
The current federal estate tax exemption is $12,060,000 in 2022. Therefore, most estates will fall below that threshold. However, each state has its own estate tax laws that may be lower.