A common misconception people have about life insurance is that they only need to designate their spouse, child, or loved one as the beneficiary of the policy to ensure that the life insurance benefits will be available to the beneficiary when they die. Life insurance is an important financial and estate planning tool, but without certain protections in place, there is no guarantee that your beneficiary will receive, or keep, the benefit from your insurance.
David identified his wife, Betsy, as the beneficiary of his life insurance policy. At David’s death, Betsy does, in fact, receive the death benefit from the insurance policy, but when Betsy remarries, she adds her new husband’s name as a joint owner of the bank account where she deposited the death benefit. In so doing, she inadvertently leaves the entire death benefit from David’s life insurance to her new husband instead of to the children she and David shared, as they had discussed before his death and as indicated in her will.
Dawn, a single mother, named her ten-year-old son Mark as a beneficiary of her life insurance. She passes away when he is twelve. The court names a relative as a guardian for Mark until he is legally an adult. By the time Mark reaches his eighteenth birthday, his inheritance has been partially spent on court costs, attorney’s fees, and guardian’s fees. In addition, its value has not kept pace with inflation because of the restricted investment options available to guardians. Dawn had hoped that the life insurance proceeds would be available to pay for Mark’s college expenses, but because of the costs and lack of investment flexibility, there is less money available to Mark. Mark receives the remaining funds, spends them frivolously, and within a year or two has nothing left.
An Alternate Beneficiary of Your Life Insurance
A common method for leaving money and property to loved ones in an estate plan is by titling assets so they are owned by a trust or making the trust the beneficiary of the account or property, with a spouse or child as the trust’s beneficiaries. The same approach may also be used for life insurance policy proceeds. Two popular ways to achieve this result are naming a revocable living trust as a beneficiary or setting up an irrevocable life insurance trust.
Revocable Living Trust
For individuals with accounts and property valued below the current lifetime estate tax exemption amount (currently $11.85 million in 2021) or for those who have already set up a trust, naming a revocable living trust as the beneficiary of a life insurance policy can be a useful option. Doing so simply adds the death benefit from the life insurance policy to what you already have in trust. And the funds are payable only to the trust’s beneficiaries according to the instructions already in the trust agreement. The benefit of this approach is that it instantly coordinates your life insurance proceeds with the rest of your estate plan.
Irrevocable Life Insurance Trust
An irrevocable life insurance trust (often called an ILIT) is an added layer of protection because it can both own the life insurance policy and be named as the beneficiary. You can create an irrevocable life insurance trust either by transferring ownership of an existing policy into the trust or by having the trust purchasing a new policy. Using your annual gift tax exclusion, you make cash gifts to the trust to pay the insurance premiums. Upon your death, the trust receives the death benefit and the trustee distributes the money according to the instructions in the trust document. This strategy also allows you to remove the value of the life insurance policy and the death benefit from your taxable estate. However, before rushing off to draft an ILIT, remember that despite the estate tax exemption currently being at a historic high, it is likely that the exemption amount will change either in the near future or sunset in 2026 at the latest.
As you can see, there are some very good reasons to consider taking the extra step to ensure that your loved ones’ financial futures are secure. If you have life insurance, and want to incorporate your life insurance into that plan, or if you are just getting started on your estate planning journey, give a call. We have help craft a plan that will help provide your family and give you peace of mind. Nielsen Law PLLC provides family-focused estate planning to individuals and families in Austin, Round Rock, Cedar Park, and the Central Texas area. For more information and to learn about our firm, please contact us.