Is Life Insurance Alone "Good Enough" for Estate Planning?
A life insurance policy is one of the best ways to ensure that your loved ones are taken care of in the event of your death. A term policy for ten or twenty years is generally inexpensive for most people and policy payouts in the hundreds of thousands of dollars can be obtained in many cases without a health exam or visits to a doctor. But is life insurance alone enough to ensure that your family will be able to access the funds readily and on the terms that you’d be happy with?
Here are five considerations to reflect on when it comes to life insurance and estate planning:
1) Naming Beneficiaries – Upon your death, life insurance is payable to whomever is named as the beneficiary on the policy. Failure to keep your beneficiaries up to date can result in unintended consequences such as distributions to ex-spouses or leaving one or more children out of an inheritance. A will does not control who gets the proceeds from a policy and a trust can only factor in if it is named as a beneficiary of the policy. If you have an old life insurance policy and you’ve been divorced and/or remarried, had new children, or had a beneficiary pass away, you should review your policy's list of beneficiaries to make sure that they are up to date.
2) Unintended Probate – In general, life insurance is not part of a person’s estate subject to the probate process. When a beneficiary is properly named, the policy contract determines the payouts; therefore, a court does not need to get involved. However, if there are no eligible beneficiaries named in the policy, possibly because of the death of named beneficiaries or a failure to update the list when children are born, the policy will be paid to your “estate”. If this happens, there is a high likelihood that these funds will now be subject to the probate process because the payout will exceed the maximum transfer allowed without a court proceeding ($150,000 in California). As I’ve discussed in earlier posts, probate is not advisable because of the fixed attorney and administration costs, as well as major delays of up to 18 months to two years before the funds become available to your beneficiaries.
3) Children as Beneficiaries – Life insurance companies will not pay proceeds directly to a minor. If a minor is named and there is no existing trust set up to take proceeds from a policy, a court proceeding will be necessary in order to appoint a guardian to manage the funds until the minor child is of age. This is a costly proceeding that will drain a portion of the funds due to the minor and delay access to possibly badly needed funds to care for your children.
4) Lack of Control – As noted above, when life insurance is paid out to beneficiaries who are under the age of majority the funds will be controlled by an administrator until the children reach eighteen years old. Once the children reach that age, they are entitled to the entire amount of the insurance proceeds. This means that your eighteen-year-old son or daughter may have access to hundreds of thousands or millions of dollars without the tools to know how to responsibly manage the money. By having those funds instead left to a trust, the parents can control how and when their children receive funds, whether it is in staged distributions or after a milestone such as college graduation or marriage.
5) Loss of Government Benefits – Finally, if any of the beneficiaries of a life insurance policies receive assistance from the government due to disabilities or other special needs, a large influx of cash, such as an insurance payout may result in the loss of government benefits. Many benefits are income-contingent and therefore the beneficiaries may have too much in assets after inheriting to qualify for further assistance. However, if that beneficiary were to inherit through a carefully crafted trust, he/she would be able to have access to the funds for their own health, welfare, and education without affecting eligibility of government assistance. This is because the funds wouldn’t be counted as the beneficiary’s assets as they would be held in trust on their behalf.
Overall, life insurance is a great tool for making sure your loved ones are taken care of if you suffer an untimely death. However, it should not be thought of as a substitute for careful estate planning handled by a trusted advisor.