Generally speaking, life insurance is paid out directly from the insurer to the beneficiaries, without going through probate. This is because life insurance is considered separate from the policyholder’s estate, such that it is not subject to debt collection or taxation. However, there are certain situations in which the death benefit from a deceased individual’s life insurance policy may be transferred to his or her estate rather than to a beneficiary. This means that it will be subject to the probate process.
“Probate” refers to the process by which a deceased individual’s estate is distributed. It frequently involves the use of the deceased’s will as a reference point naming beneficiaries, who are each entitled to a portion of the estate as distributed via an executor. Especially in the case of high-value estates, probate can be a heavily litigated process, with multiple parties claiming conflicting amounts of the deceased’s assets. It’s also important to note that the probate process varies heavily on a state-by-state basis.
When applying for life insurance, the applicant designates one or more beneficiaries to receive the policy’s death benefit. However, problems may arise when the beneficiary or beneficiaries are deceased or cannot be reached (see our previous blog post). If no designated beneficiary can be contacted to receive the death benefit, it may be added to the value of the policyholder’s estate. Consequently, the death benefit will become a part of the estate, and, therefore, will be subject to probate.
Going through probate can be disadvantageous for several reasons, even if the estate value ends up being distributed appropriately. If the insured was in debt at the time of death, his or her estate will be used to pay off any outstanding debts and can even be subject to estate taxes. Conversely, if a beneficiary receives the insured’s death benefit directly from the insurance company, the beneficiary will receive the full amount without taxation or debt collection. Many states exempt a specified amount of life insurance death benefits (e.g. up to $50,000) from debt/tax collection even after being transferred to the policyholder’s estate, but this depends on the laws in your state.
The big takeaway is that it’s in your best interest, as the policyholder, to keep your beneficiaries as up-to-date as possible so that your death benefits don’t go through probate. Life insurance is usually advertised as a “safe” investment, free from taxes and unforeseen deductions; however, if a policyholder’s beneficiary is deceased or cannot be located, the death benefit may be treated the same as any other asset and consequently be subject to debt/tax collection through probate. Designating a secondary beneficiary (or contingent beneficiary) can help provide an effective safeguard in case something happens to the primary beneficiary.
Additionally, these sorts of situations can spur legal debates over who is rightfully entitled to a policy’s death benefit. If you believe your life insurance claim has been wrongfully denied, it is prudent to get the advice of a trusted legal authority.