Updated January 26, 20227 min read
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You might already have a will and testament set up to ensure your assets are properly distributed to your loved ones when you die, but that doesn’t mean you don’t need life insurance too. While both offer financial protection to your family, they function very differently.
Life insurance is considered an income replacement and replaces any financial support you would have provided, whereas a will outlines assets you already have and how they will be divided.
If you already have a will in place, setting up a life insurance policy creates more robust financial security for your family and ensures their well-being when you’re no longer there to provide support.
A last will and testament designates who should get your estate and assets and can be used to assign a guardian to your dependents.
Life insurance coverage supplements your will and testament by providing the means to pay estate taxes or financial support to dependents.
Working with a financial advisor is the best way to analyze your assets and manage your wealth.
The biggest difference between a will and life insurance? A will legally protects assets you already have, while a life insurance policy substitutes future financial support for your dependents.
A will and testament is a legal document that distributes your assets (such as property) and settles affairs (such as how you would like to be buried). A will can instruct what and how much inheritance your dependents receive from your estate. A will also has a designated executor who serves as a legal proxy on your behalf after your death.
A life insurance policy is a contract between you and an insurance company that guarantees a death benefit for your beneficiaries when you die in exchange for the premiums you paid while you were alive. Life insurance replaces future income and financial support that your beneficiaries were relying on and can be used to pay for anything from rent to your child's college tuition.
Life insurance and wills are two separate legal entities, which means they can’t be combined or used in place of the other. When you’re setting up your life insurance policy, you designate the beneficiaries. If down the road you decide to change something in the policy, such as who receives the death benefit payout, you’ll need to do so through your insurer.
Your will can’t specify who receives money from your life insurance policy — and it can’t name someone as the new policyholder or pass your policy along. If you want to purchase a policy on someone’s behalf, you would do so directly through the life insurance company. Keep in mind, you’d need their approval and involvement in the application process, or you’re committing life insurance fraud.
The exception to this rule is if all of your beneficiaries have predeceased you. If your primary beneficiaries and contingent beneficiaries aren’t alive or able to accept the death benefit, then the cash payout goes to your estate.
When you die, a probate court determines how to distribute these assets using your will. Without a will in place, the court would decide how to distribute your assets to your loved ones.
Because your estate is distributed according to your will and testament, if your life insurance policy is paid out to your estate as a last resort, then the money would be distributed according to your will.
Additionally, you may intentionally set up your life insurance policy to be paid out to your estate, though this is usually not recommended because the death benefit can then be collected by creditors to pay for any debts you owe before it’s dispersed amongst your estate.
Though most people have a will or life insurance policy in place for the same reason — to protect the financial security of their loved ones — how each protects your loved ones varies. If you already have a will and testament, a life insurance policy can complement a will to protect your dependents and cover any estate taxes or debts you owe.
You can benefit from a life insurance policy in any of the following scenarios:
A will ensures your estate goes to your loved ones and stays out of the courts. Without a will, a judge might get to decide what happens to important property and assets, such as your home or car. If you have dependents, a will can also dictate who would take over guardianship if you died. But even in a situation where you are assigning guardianship, your dependents or designated guardian left behind still might not have the means for financial security.
That’s where a life insurance policy comes in — the income replacement life insurance provides enables your dependents to pay bills and everyday expenses that they might not be able to afford or take out from your estate. Losing your income could still be a financial burden even if they have your estate or assets to fall back on, but a life insurance policy can account for the cost they face, such as the cost of labor in raising children and or your child’s college tuition.
If you owe debts at the time of your death, these are taken out of your estate before anything (money, property, etc.) is distributed to beneficiaries according to your will. High debts can subtract substantially from what your loved ones receive from your estate. This includes anything you owe to creditors, from medical bills to mortgage payments. And while your will might lay out what funeral arrangements you’d like, that doesn’t mean that they are financially covered.
Similar to estate and inheritance taxes, an estate tied up in non-liquid assets would likely be unable to provide for these costs — but a life insurance death benefit would.
And while your family won’t technically be responsible for these debts if your estate is liquid, a life insurance policy would protect any resources they relied on by ensuring that any payments wouldn’t be taken from your assets.
The tax implications for a will are different than that of a life insurance policy. Few estates are subject to federal estate taxes, but a large enough estate of above $11.7 million in 2021 (or $12.06 million per individual for 2022 deaths) distributed through a will and testament would be subject to said taxes and depending on where you reside, possibly also at the state level.
A life insurance death benefit can help cover these costs. If your estate is made up of non-liquid assets, certain policies, such as whole life insurance, can help your beneficiaries pay the taxes they will be subject to.
On top of estate taxes, the following states have an inheritance tax that can also be paid for with a life insurance policy.
Inheritance taxes are based on the value of the assets your beneficiaries inherit and come with various stipulations depending on the state you’re in — you should check with your state’s tax department to see how your state regulates inheritance taxes. It’s important to note that inheritance taxes are only applicable if you live in one of the above states, and not if your beneficiary does.
Many of these taxes need to be filed within the first nine months of death. Because most people choose to have the death benefit paid out in one tax-free lump sum, a life insurance policy can cover these costs immediately.
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If your life insurance policy becomes a part of your estate when you die — perhaps because your listed beneficiaries are dead or you listed your estate as your beneficiary — the death benefit could be taxed if its addition increases the value of your estate enough that it’s now subject to taxes.
Any time you’re making a big financial decision, especially one that includes the financial health of your loved ones, you should work with a financial advisor to create a plan and make sure you have the proper protections in place. The right financial strategy is going to differ for each person based on their estate and dependent needs, and some people may also need to consider additional provisions, such as an irrevocable life insurance trust.
Typically, no. A will is a legal document that distributes the assets in your estate. A life insurance policy’s death benefit is not intended to be part of your estate and goes directly to the beneficiaries in your policy when you die.
A named beneficiary for a life insurance policy will always supersede a will. However, if your beneficiary predeceased you and there are no secondary or contingent beneficiaries, your life insurance policy will pay out to your estate, which will be distributed according to your will.
It’s important to update your life insurance beneficiaries after every major life event, such as a death, divorce, or marriage. If you die and your beneficiary is no longer alive, your death benefit will go to a secondary or contingent beneficiary. If there are no remaining beneficiaries, the policy will pay out to your estate and will be distributed according to your will.