When we think of the assets that we own, we generally think of stocks, bonds, real estate, and personal property. All too often we fail to think of an insurance policy as an asset. Failure to do so is a potential mistake.
If an individual owns the traditional assets mentioned above, those assets would be subject to probate at the time of the owner’s death. A life insurance policy is no different. If the owner and the insured are two different people and the owner dies first, the policy ownership has to pass to a successor owner until the death of the insured results in the proceeds being paid to a beneficiary. Probate, which is the procedure by which the ownership passes to that next owner, can cause unneeded costs, frozen assets, and the loss of time. It can also negate many of the advantages that insurance enjoys.
At the death of an owner, the policy passes as a probate estate asset to the next owner either by will or by intestate succession, if no successor owner is named. This could cause ownership of the policy to pass to an unintended owner or to be New Jersey payday loans direct lenders divided among multiple owners.
If the insured inherits the policy at his or her subsequent death, the policy proceeds may be subject to inheritance or estate taxation. Additionally, in some states, once the policy is part of the probate estate, it becomes accessible to the creditors of the decedent/owner.
The solution is quite simple. Where the insured and owner are different individuals, either name at least one successor owner or have an entity such as a trust own the policy.
Naming the Estate as Beneficiary
The general rule is to never name an estate as the beneficiary of an insurance policy. This can be a needless and costly mistake. If the insured’s estate is the beneficiary, the policy proceeds may needlessly be subject to probate, creditor’s claims, and estate or inheritance taxes (possibly both) at the state and federal levels.
The protection of life insurance from the claims of creditors takes many forms and varies from state to state, so it is important to obtain advice from legal counsel concerning your specific situation. Generally, insurance death benefits actually paid to a named beneficiary are exempt from attachment by the creditors of the deceased insured. If those policy proceeds are paid to the insured’s estate, however, they are no longer considered life insurance.
Any assets that become part of the decedent’s estate, including insurance policies and their death benefits, are also potentially subject to the time and costs of probate. If the estate is named as beneficiary, the proceeds will pass to the decedent’s heirs either by will or by intestate succession. That could result in the proceeds passing to unintended beneficiaries, including minors.
This mistake can easily occur unintentionally. If only one beneficiary is named, but he or she predeceases the insured, then by default the insured’s estate becomes the beneficiary.
(1) No estate or inheritance tax issues, (2) No concerns about a creditor reaching the policy proceeds, and (3) No concerns that the proceeds will be subject to probate,
then naming the estate as beneficiary might be appropriate. Otherwise, it is generally more advantageous to name specific beneficiaries other than an estate.
The Three-Year Inclusion Rule
If at death the insured is the owner of or has any “incidents of ownership” in a life insurance policy, the entire death benefit is includable in the taxable estate for estate tax purposes. If the insured’s total estate value including the life insurance proceeds is less than the estate tax exclusion amount ($2 million in 2008 and $3.5 million in 2009) or is passing to a surviving spouse under the unlimited marital deduction, there should not be a federal estate tax. In this situation, it may be desirable for an insured to own his or her policy.