Life Insurance and Estate Planning: Protecting Your Beneficiaries’ Interests

Life insurance is an important financial and estate planning tool, but without certain protections in place, there is no guarantee that your beneficiary will receive, or keep, the benefit from your insurance. Some people assume that they only need to designate their spouse, child, or loved one as the beneficiary of the policy to ensure that the life insurance benefits will be available to the beneficiary when they die. That assumption does not always result in providing the protections that were intended.

Example 1

Bob named his wife, Jane, as the beneficiary of his life insurance policy. Bob passed away and Jane received the death benefit from the insurance policy. Jane later remarried and added her new husband as a joint owner of the bank account where she had deposited the death benefit. In so doing, Jane inadvertently left the entire death benefit from Bob’s life insurance to her new husband, instead of to the children she and Bob shared, as they had discussed before his death and as indicated in her will.

Example 2

Katy, a single mother, named her ten-year-old son Oliver as a beneficiary of her life insurance. She passes away when he is twelve. The court names a relative as a guardian and conservator for Oliver. The conservator is given control of Oliver’s financial matters until he is legally an adult. By the time Oliver reaches his eighteenth birthday, his inheritance has been partially spent on court costs, attorney’s fees, and guardian and conservator fees. In addition, its value has not kept pace with inflation because of the restricted investment options available to the conservator. Katy had hoped that the life insurance proceeds would be available to pay for Oliver’s college expenses, but because of the costs and lack of investment flexibility, there is less money available to Oliver. Oliver receives the remaining funds, spends them frivolously, and within a year or two has nothing left.

Name a Trust as the Beneficiary of Your Life Insurance

A common method for leaving money and property to loved ones in an estate plan is by titling assets so they are owned by the trust or making the trust the beneficiary of the account or property, with a spouse or child as the trust’s beneficiaries. The same approach may also be used for life insurance policy proceeds. Two common ways to achieve this result are naming a revocable living trust as a beneficiary and setting up an irrevocable life insurance trust.

Revocable Living Trust

For individuals with accounts and property valued below the current lifetime estate tax exemption amount or who have already set up a trust, naming a revocable living trust as the beneficiary of a life insurance policy can be a useful option. When you pass away, the death benefit from the life insurance policy would be paid to the current trustee of your trust and would be held, managed, and distributed according to the instructions of the trust agreement. The benefit of this approach is that it instantly coordinates your life insurance proceeds with the rest of your estate plan.

Irrevocable Life Insurance Trust

An irrevocable life insurance trust is an added layer of protection because it can both own the life insurance policy and be named as the beneficiary. You can create an irrevocable life insurance trust either by transferring ownership of an existing policy into the trust or by the trust purchasing a new policy. Using your annual gift tax exclusion, you make cash gifts to the trust to pay the insurance premiums. Upon your death, the trust receives the death benefit and the trustee distributes the money according to the instructions in the trust document. This strategy also allows you to remove the value of the life insurance policy and the death benefit from your taxable estate.

Despite the estate tax exemption currently being at a historic high, the exemption amount may change under current efforts of Congress or sunset in 2026, at the latest. If you have purchased life insurance, consider taking the extra step to ensure that your loved ones’ financial futures are secure. To discuss your best options for aligning your life insurance with your estate plan, call us today. We are here to help.