Life insurance can be a powerful financial and estate planning tool, but its benefits may be reduced or even eliminated if you designate the wrong beneficiary or fail to change beneficiaries when your circumstances change.
Here are common pitfalls to avoid:
Naming your estate as beneficiary. Doing so subjects life insurance proceeds to unnecessary state inheritance taxes (in many states that have an inheritance tax -- Michigan does not have an inheritance tax), exposes the proceeds to your estate’s creditors and results in the proceeds going through probate, which may delay payment to your loved ones and cause additional expense to your estate.
Failing to review your beneficiary designations. We have seen instances on older policies regarding which now deceased parents are designated as the beneficiary of life insurance proceeds. In a case like this, because the beneficiaries predeceased the insured party, the proceeds will be paid to the estate of the insured, as the default beneficiary. This will result in the issues described above.
Naming minor children as beneficiaries. Insurance companies won’t pay life insurance proceeds directly to minors. As a result, a court-appointed conservator (who, if you’re divorced, could be your former spouse) will be required to manage the funds until your minor-age children reach the age of majority (i.e., the age of 18 in Michigan). A better approach is to designate a trust as beneficiary. This allows you to determine who will manage the funds and how they’ will eventually be distributed to your children.
Naming your former spouse as beneficiary. It’s unlikely that you’d do this intentionally. But if you get divorced and neglect to designate a new beneficiary, this could be the result (even if you’ve updated your will or trust).
For those clients who may have taxable estates (i.e., $5,450,000 in 2016 and expected to be increased to $5,490,000 in 2017), the best strategy may be to establish an irrevocable life insurance trust (ILIT) to purchase and own a life insurance policy, and to designate the ILIT as the policy’s beneficiary. By doing this, the proceeds of the life insurance can be excluded from the taxable estate of the insured, thus reducing potential estate taxes. For more information on how to best address your life insurance policy in your estate plan, please contact us.