If you have life insurance or plan to get a policy, you may wonder, ‘Is life insurance part of an estate?’ The answer: it depends. Many people designate a specific individual as the beneficiary of their life insurance policy, so the death benefits usually pass directly to them rather than going to the estate. However, others prefer to name their estate as life insurance beneficiary. In that case, the estate can use life insurance proceeds to offset taxes or pay a mortgage.
Life insurance estate planning is more than finding a policy and naming a beneficiary. Another concern is taxation. In some cases, life insurance proceeds can trigger estate taxes, which can significantly reduce the value of your estate to your designated heirs.1 You may work with an estate planning attorney to identify ways to mitigate your tax burden, keeping more of its value available for your loved ones to inherit.
In this guide, you’ll learn the answers to these questions:
- Is life insurance considered part of an estate?
- What happens when life insurance goes to the estate?
- Are life insurance proceeds taxable to the estate?
You’ll also learn the basics of trusts, how they impact life insurance proceeds, and some state-specific regulations to be aware of.
Ready to get started?
Life Insurance and Estate Planning: A Detailed Explanation
Life insurance is a policy that provides death benefits to your named beneficiary when you die. To get life insurance, you sign up for a policy with the coverage you need. Your coverage remains in place until it expires, you stop making payments, or you pass away. If you have an active life insurance policy when you die, your beneficiaries can use the proceeds for different purposes, including your funeral and burial, paying off debts, or replacing your income.
Estate planning defines how you want your assets distributed or managed once you die. Your estate plan may include a will, life insurance policies, and any titles for items you own.
Life insurance typically plays a key role in your estate plans. It can provide a monetary legacy for your loved ones or help offset any debts and taxes so your heirs receive what you want them to. Some people designate a favorite charity to receive life insurance proceeds, providing a long-lasting legacy that benefits causes important to them.
Benefits of Naming a Beneficiary
When you buy a life insurance policy, you’ll have the opportunity to name a beneficiary. Most life insurance companies require you to name a primary and a contingent beneficiary. The primary beneficiary is the person you want to receive the proceeds, while the contingent beneficiary acts as a backup. The contingent beneficiary receives the funds if your primary beneficiary can’t. For instance, if the primary beneficiary dies before you, and you don’t name a replacement beneficiary, your contingent beneficiary receives the death benefits.
You can name any person or entity as a beneficiary on your life insurance policy. Most commonly, policyholders name a spouse, partner, adult child, extended family member, business partner, or charitable organization.
If you don’t name a beneficiary, no one will know who you want to receive the death benefit payout. Your insurer may distribute the benefits according to the policy’s terms or pass it directly to your estate. If the payout goes to your estate, it may need to undergo a lengthy and expensive probate process, potentially derailing your estate plan.
Trusts as Beneficiaries
There are several types of trusts, but they all fall into two categories: revocable and irrevocable. Some people name trusts as life insurance beneficiaries, especially if they want life insurance proceeds to be managed in a particular way or to go to a minor child.
Revocable trusts name a grantor to oversee the assets in the trust. Usually, the grantor is you, and you can make changes to the trust throughout your lifespan. You’ll also name a successor trustee, who acts as a backup and takes responsibility for managing assets once you die or become mentally incapacitated. Assets from a revocable trust don’t undergo probate, which is one reason why people create them. However, a revocable trust isn’t protected from creditors and may still incur estate taxes.
An irrevocable trust allows you to distribute assets among specific beneficiaries. However, you can’t name yourself as the grantor, and once you establish an irrevocable trust, it’s extremely difficult to modify. Irrevocable trusts bypass probate and are not subject to estate taxes, making them an attractive tax planning tool. If you name an irrevocable trust as the beneficiary of your life insurance policy, the irrevocable trust will distribute the funds according to the terms provided for in the trust.
Life Insurance in the Probate Process
Once you die, your assets usually go through a legal process known as probate. If you leave a will and designate an estate executor, they will collect all your assets and pay off any remaining debts in your name. The remaining leftover assets are distributed to your beneficiaries, which you name in your will.
Problems arise when you don’t have a will or a named executor. In that case, a court will name an administrator to oversee your estate’s distribution. The court will locate your existing heirs and decide how to distribute your assets according to state probate laws. However, the state’s probate laws may not align with your wishes, so your heirs may not receive what you want them to.
Life insurance payouts usually aren’t considered part of your estate, so they avoid the probate process. Instead, the death benefits go directly to the designated beneficiary on your policy or the contingent beneficiary if the primary one is no longer living. However, if no beneficiary exists or they’re no longer alive, your life insurance benefits will pass to your estate. If that happens, the life insurance policy becomes part of the estate probate process.
Sometimes, policyholders name their estate as their beneficiary for specific reasons, such as offsetting estate taxes or paying off debt. If you decide to name your estate as a life insurance beneficiary, your estate executor or administrator will use the proceeds for their intended purpose and distribute the remainder to your heirs or other beneficiaries according to your estate plan.
Estate Tax Implications
In most cases, your beneficiaries receive any proceeds from a life insurance policy tax-free. However, there are two exceptions when the life insurance policy may be subject to estate taxes:
- You name your estate as the beneficiary
- You own and are insured by the life insurance policy
For instance, say you purchase life insurance on yourself and name your adult child as a beneficiary. Since you own the policy, the proceeds become part of your estate, even though you name someone else as the beneficiary. If the value of your estate, including the life insurance benefits, exceeds federal and state estate tax exemption limits, the proceeds may be subject to estate taxes.
However, say your adult child buys a life insurance policy on you and names themselves as the beneficiary. In this case, your adult child receives the proceeds entirely tax-free. They do not pass to your estate since you don’t own the life insurance policy.
Keep in mind that just because your life insurance policy passes to your estate does not mean your heirs will owe estate taxes on the proceeds. The federal exemption limit for estate taxes is $13,610,000 in 2024, meaning your estate must be worth more than that to begin incurring estate taxes. If your estate is worth less than that, your heirs won’t need to worry about federal estate taxes, regardless of whether you own the policy.2
However, the exemption limit for states varies and, in some cases, may be less than the federal exemption. If your estate value exceeds state exemption limits and you own your life insurance policy, the beneficiary may owe estate taxes on the proceeds.
Find a policy that works for you
There are a range of affordable Fidelity Life products to choose from based on your situation and financial responsibilities.
State-Specific Regulations
Every state sets its own rules for estate tax and life insurance proceeds. While the general rule is beneficiaries usually don’t owe tax on life insurance benefits they receive, an estate tax may apply in certain circumstances.
For instance, if you buy an insurance policy on yourself and leave it to a beneficiary, and the value of your estate, including the value of your life insurance policy, exceeds state limitations, it may incur estate taxes.
Here are the current 2024 estate tax exemption limits in several states:3
- Connecticut: $13,610,000
- Washington, D.C.: $4,715,600
- Hawaii: $5,490,000
- Illinois: $4,000,000
- Maine: $6,800,000
- Maryland: $5,000,000
- Massachusetts: $2,000,000
- Minnesota: $3,000,000
- New York: $6,940,000
- Oregon: $1,000,000
- Rhode Island: $1,774,583
- Vermont: $5,000,000
- Washington: $2,193,000
Another tax that may apply is inheritance tax. An inheritance tax applies to recipients who inherit assets from a deceased individual. There is no inheritance tax at the federal level, but six states currently have one, including Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania.4
While the state laws on inheritance tax differ, most states that impose it exempt spouses and immediate family members from paying the tax. However, non-lineal descendants may owe taxes on assets they inherit.
Life Insurance Proceeds and Estates: Examples
Since estate planning life insurance rules can be confusing, here are a few examples to consider.
You Name Your Estate as a Beneficiary
Assume your estate is worth $5,000,000, and you live in Illinois. You know your estate will qualify for state estate taxes, so you decide to name your estate as the beneficiary to your $500,000 life insurance policy, which may help offset the taxes owed. In this case, your estate gets the insurance proceeds, and your estate’s executor or administrator can use the benefits to pay state estate taxes. Whatever is left over from the life insurance policy and your estate will go to your heirs.
Your Spouse Holds a Life Insurance Policy on You
It’s common for spouses to take out life insurance policies on each other. The proceeds from a policy can act as an income replacement or cover debts, such as an outstanding mortgage or credit card. It may also pay for funeral and burial expenses. In most cases, life insurance proceeds left to a spouse are exempt from estate taxes at the federal level, even if the estate’s value exceeds the federal exemption limit. However, states may consider it differently, so it’s important to review your state’s laws to understand whether estate taxes apply.
How to Change Beneficiaries
If you are the policyholder of a life insurance policy, you typically retain control over who you choose as a beneficiary. If you need to update your policy to reflect a change in the beneficiary, you can notify the insurance company. You may need to provide the following information:
- Full legal name of the new beneficiary
- Date of birth
- The beneficiary’s relationship with you
- Social Security number
- Contact information, such as phone number, physical address, and email
An exception applies if you’re married and live in a community property state. In that case, if you purchased the life insurance policy during your marriage, you must obtain your spouse’s permission before naming someone else as the beneficiary.5
Frequently Asked Questions (FAQs)
Is Life Insurance Part of an Estate After Death?
In some cases, yes. If you name your estate as the beneficiary of your life insurance policy, the proceeds become part of your estate. Life insurance proceeds can also become part of an estate if you own and control the policy rather than someone else, such as a spouse.
Is Life Insurance Included in Gross Estate Values?
If life insurance proceeds meet the requirements to be included in an estate, the gross value is included.
How Are Survivorship Life Insurance Policies Helpful in Estate Planning?
A survivorship life insurance policy covers two people and only pays out to beneficiaries once both individuals die. The death benefits are typically tax-free, allowing heirs to pay estate taxes, probate costs, and other administrative fees without dipping into their savings.6
How Does Life Insurance Create an Immediate Estate?
Life insurance can go to the deceased individual’s estate or to beneficiaries. Beneficiaries can use funds for replacement income, funeral and burial, and debt repayment.
Ready to get started?
Consulting with Professionals
Estate planning and life insurance can get complicated very quickly. To avoid any mistakes that derail your wishes, consulting with a qualified estate planning attorney is smart. While it may cost you some money upfront, working with a lawyer can help you set up an estate plan that aligns with your wishes and mitigates tax liability.
Life Insurance Is Key to Estate Planning
No one likes to imagine their death, but it’s an unavoidable part of living. You can protect your loved ones and secure their future by setting up a comprehensive life insurance and estate planning arrangement. Since you likely have specific circumstances you want to address through life insurance, it’s a good idea to speak with professionals who can provide tailored advice that fits your needs. Fidelity Life is here, and we can help you select a policy that works for you. To speak with a Fidelity Life agent, call 855-741-1441 or email us at sales@FidelityLife.com.
Article Sources:
- Yahoo!finance. “Taxes on life insurance: Here’s when proceeds are taxable, https://finance.yahoo.com/news/taxes-life-insurance-proceeds-taxable-145158905.html”
- IRS. “Estate tax, https://www.irs.gov/businesses/small-businesses-self-employed/estate-tax”
- ACTEC. “State Death Tax Chart, https://www.actec.org/resources-for-wealth-planning-professionals/state-death-tax-chart/”
- smartasset. “A Guide to the Federal Estate Tax for 2024, https://smartasset.com/taxes/all-about-the-estate-tax”
- Policygenius. “Can you change your life insurance beneficiary?, https://www.policygenius.com/life-insurance/can-you-change-your-life-insurance-beneficiary/”
- Forbes Advisor. “What Is A Survivorship Life Insurance Policy?, https://www.forbes.com/advisor/life-insurance/survivorship-life-insurance/”
