Nature of Asset
A life insurance policy is a contract between the insurance company and the person who buys it, either to insure her own life or that of someone else. The policy owner pays the premiums and in exchange, upon the death of the insured, the insurance company pays a death benefit to whomever the policy names as the beneficiary. The only way it can become part of the deceased’s estate is if the policy owner instructs the insurance company to pay the estate or if she neglects to name another beneficiary. In that case, the death benefit would go to the estate by default.
If you name a loved one as the beneficiary on your life insurance policy, he does not have to wait to receive the death benefit until after the probate process, which can take from a few months to more than a year, depending on the size of your estate. Fees incurred during the probate process, such as expenses of settling the estate and claims by the estate’s creditors, cannot whittle away and reduce the death benefit on the insurance policy.
Life insurance policies are subject to federal estate taxes whether the death benefit passes to the estate or to a named beneficiary. According to the Mamola Law Firm, this can be from 45 percent to 47 percent of its value. If your estate is the beneficiary of the policy, in most states, the insurance company is obligated to issue a check for the death benefit directly to the probate court. The probate court will use the money first to pay probate fees and attorney fees. Your heirs get the balance according to the terms of your will.
Trusts are not subject to estate taxes, according to the Mamola Law Firm. Therefore, if the named beneficiary of your life insurance policy is an irrevocable life insurance trust, the trust can receive the death benefit without paying taxes on it and can mete it out to whomever your choose. An irrevocable life insurance trust is essentially an additional step in the process. The death benefit would pass from the insurance company to the trust to your desired beneficiary rather than from the insurance company directly to your desired beneficiary, who would lose nearly half of it to taxes. Once such a trust is set up, however, you can’t change it and lose the right to borrow from the policy if necessary because you are no longer the owner -- the trust is. And if you transfer an existing life insurance policy to the trust and die within three years, the tax benefit is lost.