Berman & Asbel, LLP

Be careful with life insurance beneficiary designations when planning estate

Let's suppose you have gone to your attorney for your estate plan.  You have a will which provides your children's inheritance will be held in trust until they are old enough that their education is paid for and that they are not so likely to blow the money on fancy cars, vacations, dating expenses or other uses of which you might not approve.  You have named guardians for your children if they are underage.  Are you done?  Not necessarily.

What about your life insurance?  Perhaps you have enough life insurance but how will it pay out and to whom?  Many people will go to the trouble to prepare a plan for the handling of their assets they acquire during their lifetime but perhaps not their life insurance.  Often one will name a spouse as the primary beneficiary and then their children if the spouse is not living.  Sometimes, however, such a simple insurance beneficiary designation is inconsistent with and can even destroy an estate plan.  For some people, the bulk of the money they are leaving to their families is in a life insurance payout.  Many people think that the insurance will be paid as their will instructs but that is only automatically the case if they have a will and then either name their estate as the beneficiary or have no named beneficiary at all - and that can create other problems.
If the life insurance beneficiary designation is different than what is in the will, the insurance company must pay it to whom the beneficiary designation says, not the will.  This is because a will only controls "probate assets" - assets that one owns during one's lifetime or which are paid to the estate.  When an insurance policy (or retirement account or annuity) has a named beneficiary, that trumps the will.  
A variety of problems can arise when a life insurance policy beneficiary designation does not match an estate plan's goals.  Suppose your spouse is deceased and the next beneficiary is your children but they are under 18.  In that case, the insurance company cannot pay out the proceeds until a guardian of the child's estate is appointed by the court.  In Pennsylvania, in such a guardianship, the surviving parent cannot be the sole guardian and there are numerous legal restrictions placed on how and why the money can be used before the child turns 18 including the need to petition the court for approval to use those funds.  This can add significant costs to the estate administration and result in great inconvenience for the family.  If the child is over 18, the insurance company will have to pay the young-adult child all that money regardless of whether they have the maturity you would want them to have with that money.

One method to coordinate life insurance with your estate plan is to have the written beneficiary designation parallel your will.  For example, if your will says that your estate goes to your children but their shares are to be held in trust until age 25, your life insurance beneficiary designation for your children can say that the proceeds are to be divided equally among your children provided that if any of them are under age 25, that child's share shall be paid to the trustee named in your will. An experienced attorney can assist you with drafting an appropriate set of beneficiary instructions for your life insurance policy.  Before paying out the proceeds to a trustee, the insurance company will require a certified copy of the will and documentation that it was admitted for probate and documentation that the trust is open and ready to receive the funds.

Another simple but not necessarily advisable method to coordinate life insurance with your estate plan is to simply have your estate be the beneficiary of the life insurance policy and then the proceeds will be handled according to your will. This is a simple technique but has a downside - the Pennsylvania inheritance tax.  The Pennsylvania inheritance tax does not include life insurance proceeds IF the insurance policy beneficiary is a named beneficiary and not simply the estate.  If the estate becomes the beneficiary, then that money is subject to inheritance tax. For an inheritance to children, grandchildren or further descendants, the tax rate is 4.5 percent.  With a $1 million insurance policy, that would add $45,000.00 to inheritance tax.  In addition, if the proceeds are paid to the insured's estate, they are subject to the insured's creditors.  So if the insured dies owing more money than is in the estate but then life insurance is paid in, that insurance money would go toward debts before any gets to beneficiaries.  Having the insurance pay directly to beneficiaries or to a trust keeps the insurance money away from such creditors.

Another method to coordinate your life insurance and your estate plan is if you have an irrevocable life insurance trust which is the beneficiary of the life insurance policy.  In such an arrangement, the trust is already in operation and the proceeds are paid to the trustee.  The trustee then uses that money to carry out the instructions in the trust.  An irrevocable life insurance trust might be used when needed to prevent life insurance proceeds from being counted as part of the estate and triggering federal estate tax.

An effective estate plan should have all of its different parts coordinated and working together.  Make sure yours is set up to accomplish your goals.

Readers should not rely on this note as legal advice but should consult with a competent attorney licensed in their state.  You can also find more information in our firm's websites on Family Law and Wills and Estate Planning and Administration.

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