For many people, avoiding the probate process and having their assets pass outside of probate after their death is a priority. Ordinarily, having a life insurance policy does not interfere with that goal. In most cases, the proceeds of a life insurance policy pass directly to the named beneficiary without any probate involvement.
However, there are circumstances in which life insurance benefits must go through probate, which can delay payment to loved ones and even reduce the amount of funds available through the policy. Fortunately, there are relatively simple ways to avoid these situations, and ensure that funds are available for you loved ones when they need them.
What happens if you have someone named as the beneficiary of your life insurance policy, and your beneficiary dies? The answer depends on when the beneficiary dies. If they die before you, the policy benefits will go to any co-primary beneficiaries; for instance, if your three children, A, B, and C are your primary beneficiaries, and A predeceases you, the policy will still go to B and C. No probate problems.
If all of your co-primary beneficiaries predecease you, however, the insurance company will pay the policy benefits to a secondary or contingent beneficiary if you have one. If you have no contingent beneficiary, the life insurance benefits will be paid to your estate, and they will have to go through probate.
Another situation in which your life insurance benefits may need to go through probate is if the named beneficiary is a minor child. For instance, you might name your spouse as beneficiary of your policy and your child is a contingent beneficiary. Being young and healthy, you might expect that no one would need to make a claim against the policy for years, until your spouse is old and your child grows up. If a catastrophe happens, however, and you and your spouse pass away while your child is still a minor, your child cannot legally take ownership of the life insurance benefits.
Instead, those assets go through probate, and a guardian will be appointed to hold and manage the life insurance benefits until your child is a legal adult at eighteen. At that time, though, he or she will have access to all the benefits at once, without restriction. If you (like most parents) think it's probably not a great idea for an eighteen year old to have unfettered access to hundreds of thousands of dollars, it's time to consider another plan.
A simple and effective way to keep life insurance benefits out of probate and more readily accessible is by making a trust the owner and beneficiary of the life insurance policy. An irrevocable life insurance trust (ILIT) accomplishes a number of goals in addition to avoiding probate: avoiding estate taxation of death benefits, meeting the needs of your estate with regard to liquidity, sheltering assets from creditors, and, of course, providing for your surviving loved ones. You can also make a revocable trust the owner and beneficiary of a life insurance policy. While not exempting death benefits from estate taxation, this type of trust has numerous benefits.
If you have life insurance, and wish to avoid probate, speak with your estate planning attorney about establishing a trust to serve as beneficiary of your life insurance policies.