How life insurance works with wills and trusts

Wills and trusts work alongside life insurance to help protect your loved ones after you die.

Your last will and testament and your life insurance are both necessary parts of your financial plan. Both a will and life insurance can help support your loved ones after you die by providing for them with the resources they need to pay their expenses.

Life insurance pays a death benefit to any person or organization you name as a beneficiary on your policy. Your last will and testament distributes the assets in your estate to the beneficiaries you name in the will. In both cases, the beneficiary can be a trust, which owns the asset until the beneficiaries of the trust are allowed to access it.

Can I use my will to distribute a life insurance death benefit?

A life insurance policy has a specified beneficiary. That means that if you named someone as a beneficiary of your life insurance, the death benefit will be paid out to directly to him or her after you die. The money never goes to you, so it wouldn’t be distributed as part of your will.

(Your life insurance has both primary beneficiaries, who get paid first, and contingent beneficiaries, who get paid if the primary beneficiaries are no longer alive or can’t be located.)

Read more about beneficiaries.

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When life insurance does go through probate

When you write a will, you’re creating a legal document that distributes the assets in your estate. The life insurance death benefit is not intended to be part of your estate because it is payable on death – it goes directly to the beneficiaries in your policy when you die.

But if all your specified beneficiaries have predeceased you, then the life insurance death benefit is generally paid out to your estate. That means it will be distributed to the beneficiaries of your will, if you have one, depending on the terms of the will. If you don’t have a will, state law will determine who gets the proceeds. 

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Why you should specify beneficiaries

It’s generally better to specify beneficiaries and contingent beneficiaries in your life insurance policy than to have your policy pay your estate.

First, if your life insurance pays out to your estate, your creditors may be able to get part of the death benefit.

Second, if your life insurance pays out to your estate, it could impact the taxes and probate fees owed. For example, in California, probate fees are charged at a percentage of your estate. If life insurance proceeds are paid to your estate, you may pay as much as a 4% fee on the policy’s value -- a cost that could be avoided simply by naming specific beneficiaries.

For that reason, you should always update the beneficiaries of your life insurance policy.

Does my life insurance need to have the same beneficiary as my will?

No, your will and your life insurance do not need to have the same beneficiary. But it’s important to keep in mind that updating one does not update the other and consider how the two will work together when doing your estate planning.

Putting the life insurance death benefit in a trust

One benefit of a trust is that it allows you to distribute money over time or keep money managed by a trustee and only used for specific purposes (e.g., housing, education). Many people want assets going to their children held in trust and only used for specific purposes until they reach a specified age where they can be responsible on their own for a potentially large amount of money.

A life insurance payout directly to named beneficiaries or distribution of life insurance proceeds through your will pay out all at once. However, if you have created a trust in your estate plan -- either because you have a testamentary trust as part of your will or you create a separate revocable trust -- you can direct the life insurance death benefit to be paid to the trust rather than directly to certain beneficiaries. This captures the same benefits of having money paid directly to beneficiaries (avoiding creditors, probate costs, and potentially taxes), but adds the ability to have funds managed by a trustee and distributed according to your instructions in the trust.

Irrevocable life insurance trust

Certain types of trusts can also provide tax advantages. 

The value of a life insurance policy is generally included in the value of your estate for estate tax purposes. While the federal estate tax threshold is currently $11.7 million, state limits can be much lower. For example, in Massachusetts and Oregon the limit is just $1 million. A life insurance policy may be sufficient to put you over that limit. 

Estate taxes can be avoided, however, if you are neither the owner or beneficiary of a life insurance policy. Making sure you are not the beneficiary of the policy is simply a matter of designating beneficiaries other than your estate (e.g., your spouse, children, or a revocable trust). But making sure you’re not the owner can be more complicated.

That’s where an irrevocable life insurance trust (ILIT) comes in. An ILIT is a special type of trust that only holds life insurance policies. With an ILIT, you pay the premiums associated with the policies and the fees for administering the trust out of cash assets owned by the trust. When you die, the death benefit is paid to the ILIT and its proceeds distributed to the beneficiaries named in the trust. 

ILITs can be complicated, though. First, it’s irrevocable -- once you’ve set it up, it’s difficult if not impossible to change the terms of who gets the proceeds and on what terms. Second, you must make sufficient deposits to the trust’s cash-assets account to cover administration fees as well as policy premiums. Also, if you have an existing life insurance policy you want to transfer into a trust, the tax benefit will not apply if you die within the first three years of the transfer.

For these reasons, ILITs are not the best choice for most people. But they may be useful if you’re in a low estate tax state or are considerably wealthy.

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