Estate planning is one of the most challenging and crucial financial planning tasks you’ll ever go through. It’s complicated, and the size of your estate makes it more difficult. When drafting, you might worry whether your life insurance policy will be included in your estate plan. Your beneficiary selection ultimately decides where the money goes and how it will affect your estate. As you create your estate plan, consider engaging with a financial counsellor.
Understanding estate planning and life insurance
An individual effectively contracts with an insurance provider when they buy a life insurance policy. The policy owner can then use it to insure themselves or someone else. The policyholder gives the company recurring premium payments throughout their life. The business then disburses a lump sum of money known as the death benefit to the policy’s beneficiaries following the terms of the contract once the covered person passes away.
Instead, policyholders can designate their estate as the life insurance policy’s beneficiary. If so, the money will likely be used to settle outstanding loans or expenses. Additionally, this may occur by default if the policyholder doesn’t designate a beneficiary.
The insurance proceeds may be subject to federal estate taxes regardless of whether they pass to a designated recipient or your estate. Depending on your gross estate, rates range from 18% to 40%.
The insurance company must pay the probate court directly if the estate is listed as the policy’s beneficiary. The court first uses the money to cover related legal expenses, such as court costs. The remaining funds are then distributed following the decedent’s bequest.
However, the proceeds of your life insurance policy will go to the beneficiaries you choose if you buy one and at least one of them is still living when you pass away. Since this is a direct transfer, the probate process is completely avoided.
The deceased’s estate, debts, and lines of credit are often sorted through a long and expensive sequence of court proceedings. Following the decedent’s demise, the court uses funds from the estate to settle any outstanding obligation. But when a beneficiary is named, the money belongs to that person alone; the court and creditors cannot access it.
Choosing a Trust as the Beneficiary of Your Life Insurance
It can be challenging to ensure your beneficiaries are cared for. You want to ensure that they get everything they require and are assisted in maximizing their potential future benefit. To do that, you must reduce future taxes on everything you pass on.
A trust can be named as the principal beneficiary of your life insurance policy to reduce the tax burden on the pay-out. They employ an irrevocable trust in particular. You, as the grantor, cannot alter irrevocable trust. Once you establish the trust, only the beneficiaries can authorize changes. You can save money by designating an irrevocable trust as the beneficiary and avoiding paying taxes. After then, the trust’s named beneficiary can withdraw the money.
While your beneficiary won’t receive the money directly, as a result, it is still preserved. In this manner, estate taxes are avoided from impacting the finances. But doing so has a price. Once the insurance has been given to the trust, it cannot be touched, amended, or borrowed against.
A revocable, or flexible, trust is an alternative. If your situation changes, these offer more flexibility, which could be helpful too. They also assist loved ones in avoiding the process. But even though you hold property through a revocable trust, it still counts as part of your estate. Therefore, you or your beneficiaries cannot avoid estate taxes using a revocable trust. However, this might be fine for smaller estates that are exempt from the inheritance tax.
In the end, you might not even require a trust. Due to the maximum marital deduction, there is typically a fine if your spouse is listed as the policy beneficiary. As long as one spouse is a citizen of the United States, there is no estate tax when assets are transferred between spouses.
Conclusion
When naming a beneficiary, life insurance policyholders must remember a critical tip: be specific. Nothing should be left to speculation. If you’re concerned about your intended beneficiary passing, give several names. But give each one a unique name.
If not, they might be forced to wait long to get the policy’s death benefit. If the situation is exceptionally murky, they might even need to fight it in probate court. Probate is time-consuming—it might last for more than a year—and expensive. By taking care, you can assist your loved ones in avoiding that.
