Is life insurance part of an estate?
Life insurance proceeds usually bypass the estate and go directly to named beneficiaries, but if there are no beneficiaries, the proceeds may become part of the estate assets.
The life insurance death benefit isn't intended to be part of your estate because it's payable on death — it goes directly to the beneficiaries named in your policy when you die, avoiding the probate process. However, life insurance proceeds are considered part of an estate for tax purposes.
Creditors will not be able to take the death benefit payout for your life insurance policy unless you leave the money to your estate. If you name other people as your beneficiaries, the money will go to them and the creditors won't have access to it.
- Funeral expenses: According to the National Funeral Directors Association, the median cost of a U.S. funeral with a burial and viewing was $7,848 in 2021. ...
- Outstanding debts: If you have any debts when you pass, they may become the responsibility of your heirs.
A will cannot override a beneficiary designation because the policy is a contract between the person who purchases it and the issuer. The only way anyone can override a beneficiary other than the policyholder is if a court determines there's a conflict between named beneficiaries and state laws.
An insurance trust can be an easy way to shelter the insurance proceeds from eventual estate taxes and prevent those proceeds from pushing your spouse's estate value over the estate tax exemption threshold.
Life insurance payout options
Typically, your payment options include a single lump sum, installments over time, or delayed payment, which enables you to collect interest while you plan your next move.
Upon your death, unsecured debts such as credit card debt, personal loans and medical debt are typically discharged or covered by the estate. They don't pass to surviving family members. Federal student loans and most Parent PLUS loans are also discharged upon the borrower's death.
Using life insurance policies held in an ILIT allows you to protect wealth from creditors and judgments, which can become a major risk for high-net-worth clients. An ILIT also has the benefit of decreasing the value of an individual's estate in order to reduce a future estate tax liability on the insurance proceeds.
If you receive life insurance proceeds payable directly to you, you don't have to use them to pay your parent's debts. As the named beneficiary on a life insurance policy, that money is yours to use.
Why is term life insurance an important component to estate planning?
Life insurance can provide ready cash to your beneficiaries. The liquidity of a death benefit can help cover your family's immediate financial needs, replace future income and help them reach important financial goals — providing cash to compensate for the loss of planned savings and potential earnings.
If your life insurance policy lacks a beneficiary, it will become a part of your estate when you die. When this happens, the death benefit is subject to certain estate taxes and fees and may be used to pay off debts before being distributed to your heirs.
Usually, if the beneficiary on the policy is the estate, then the insurance company must directly pay the probate court. The court first uses said money to pay associated legal costs, like court fees. Afterward, it distributes whatever amount is left according to the deceased's will.
Executors are bound to the terms of the will, which means they are not permitted to change beneficiaries. The beneficiaries who were named by the decedent will remain beneficiaries so long as the portions of the will in which they appear are not invalidated through a successful will contest.
This person or entity receives the payout if the primary beneficiary is no longer alive when the policyholder dies. Even if the payout goes directly to a beneficiary, the funds are still considered part of your estate for tax purposes if you own the policy.
If you take out a life insurance policy without naming beneficiaries, the proceeds will go to eligible blood relatives based on who is next of kin. This is the general order: Your spouse (or domestic partner) Adult child (even if adopted)
The Three-Year Rule
Under this IRS rule, the transfer must: (1) take place within three years before the original owner's death and (2) be made without any consideration. If both are the case, then the proceeds from the policy are counted in the decedent's estate for tax purposes.
According to the IRS, if life insurance proceeds are included as part of the deceased's estate and together, exceed the federal estate tax threshold of $12.92 million (as of 2023), estate taxes must be paid on the proceeds over the allowed limit.
The death benefit of a life insurance policy is not considered an asset, but some policies have a cash value, which is considered an asset. Only permanent life insurance policies, like whole life, can grow cash value.
The easiest way to learn if you are a life insurance beneficiary is to talk to the policyholder if they are still alive. They can tell you whether you're a beneficiary and provide information necessary to claim the death benefit when they pass away.
What happens if taken as a lump sum life insurance proceeds to beneficiaries?
In general, beneficiaries do not need to pay taxes on the life insurance death benefit they receive, especially if they receive it as a lump sum.
Your beneficiaries will receive a single payment that includes the entire death benefit. Specific income payout. In this scenario, the death benefit will be placed by the insurer into an interest-bearing account, and beneficiaries receive monthly or annual payments of an amount they choose.
For survivors of deceased loved ones, including spouses, you're not responsible for their debts unless you shared legal responsibility for repaying as a co-signer, a joint account holder, or if you fall within another exception.
You are generally not responsible for someone else's debt. When someone dies with an unpaid debt, if the debt needs to be paid, it should be paid from any money or property they left behind according to state law. This is called their estate.
It may be a surprise to many that life insurance benefits are, in most cases, completely untouchable by the IRS. As a beneficiary, you never need to worry about your life insurance payout being seized. In place of seizing life insurance benefits, the IRS will instead look towards the estate of the deceased.
