It is fairly common for an individual with a spouse or family to take out a life insurance policy, to provide financial security in the event they pass away. Depending on one’s age, life insurance policies are fairly inexpensive, and may even be offered as an employment benefit. For young people, the policy payout amount could be one of their primary ‘assets’ if they die.
However, if you are thinking about making an estate plan you might not know how life insurance will affect that plan or your choices. It is likely more people have life insurance policies than estate plans, so this is a frequent situation faced by those new to estate planning.
Life Insurance Beneficiaries
First, all life insurance policies have specific named beneficiaries, which can be changed at any time if desired. This is true whether you have a will or trust, or no estate plan at all, as the policy is a separate document.
If you make an estate plan, it will not override the beneficiaries in the policy, and they will receive the proceeds as designated. One advantage to this is that life insurance payments are usually quicker than distributions of the estate plan assets, so the named heirs would have access to those resources.
Estate Plan Beneficiaries
Typically, your estate plan beneficiaries will be the same as in your life insurance policy, so the effect of having the two separate designations may be minimal. Also, some individuals will use the policy to take care of a single beneficiary who might only get a portion of the estate plan.
The policy payout amounts will not affect distributions in the estate plan.
Making the Estate the Beneficiary of the Policy
One common strategy is to change the life insurance beneficiary to name the estate, such as a living trust. This essentially transfers the policy payout to the trust and then it is administered alongside all other assets.
This is especially important for minor beneficiaries when you want the life insurance to be used for their care when they are minors.
One overlooked advantage of this method is that by naming the trust as beneficiary in the policy, the trust then becomes ‘funded’, which is one legal requirement for a valid trust. Essentially it means that there is now a real asset in the trust, even if you don’t have other significant assets to list.