How Should I Handle My Life Insurance With Regard to My Estate Plan?

In most circumstances, you will want to list your revocable trust as the beneficiary of your life insurance policy. There are exceptions to this rule, but in general, listing your trust is the best alternative. The reason is because it will insure that a payout reaches your eventual beneficiaries. For example, if you are married and have a joint trust in California with your spouse, listing your trust as the primary beneficiary of your life insurance policy will ensure that the money will pass on to your children and even be protected in a continuing trust (if you have set this up in your trust). The reason putting the trust on as the primary beneficiary usually makes the most sense is because if you and your spouse were in a common accident and one of you passes away and the other is on life support, you do not want the life insurance company paying out to the surviving spouse and the proceeds not reaching the trust. Later if the surviving spouse passes away, that money will already be under the protective shield of the trust for your children and you don’t have to worry about the life insurance proceeds inadvertently going through probate.

Each insurance company will have its own preferred format for designating your revocable trust as the beneficiary. An example for a married couple in California might be: “The Smith Family Trust dated October 26, 2012.” They will have their own beneficiary form for you to fill out to effect the change. The insurance company usually will send you a letter confirming the change of the beneficiary to your life insurance policy. It is best to place that letter under the trust assets tab of your estate plan binder.

One word of caution…life insurance death benefits are includible in the calculation of your estate for estate tax purposes. What this means is that you may be over the federal estate tax exemption limit because of the size of your life insurance policies. For example, a single person currently has a $5,120,000 federal estate tax exemption. We will use Tom Smith in our example. Tom has a primary residence worth $2,000,000, a business worth about $1,500,000, a brokerage account with $1,000,000, cash accounts valued at $500,000 and a life insurance policy valued at $2,000,000. Tom’s estate (less any debt) is valued at $7,000,000. If Tom dies while the estate tax exemption is $5,120,000 (which it is in 2012 until year end), his estate will owe a 35% tax on $1,880,000 (provided Tom has not made any life time gifts over the annual exclusion amount – currently $13,000). In Tom’s situation, his children will need to write a check in the amount of approximately $658,000 from his estate to the federal government. One solution to this problem is to instead have your life insurance owned in an Irrevocable Life Insurance Trust.