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How Life Insurance Fits Into Your Estate Planning With Wills and Trusts

Learn how life insurance and associated policies may work in conjunction with other estate planning instruments such as wills and trusts.

Estate planning, including life insurance, wills and trusts, sounds complicated.

That’s for a good reason. It can be and often is.

Each state has different laws you must follow when planning how to pass assets on to your heirs.

Each person or family has entirely different sets of circumstances, assets and wishes.

One common question that pops up is how life insurance fits in with estate planning.

The answer isn’t as intuitive as you’d think.

You may also wonder if you’re solely responsible for figuring out how it all works together.

Thankfully, you don’t have to figure it out on your own.

In fact, you should likely consult a professional about your specific situation.

That said, here’s some general information about how these concepts intertwine with each other.

What Is Life Insurance?

Life insurance works to protect your family members financially should you pass away.

You purchase a policy from one of many life insurance companies.

The policy states a death benefit amount that gets paid to beneficiaries when you die.

To keep the policy in force, you make life insurance premium payments.

For the life insurance proceeds to be paid out, the policy must be in effect at the time of death.

  • Some life insurance lasts your whole life. This is called permanent life insurance.
  • Other life insurance only stays in effect for a set period. This is called term life insurance.

Either way, the money from the policy gets paid to people you designate.

Beneficiaries

These people are called your life insurance beneficiaries.

Choosing beneficiaries and keeping them updated is extremely important.

You may be able to update your beneficiaries at any time, depending on your circumstances.

There may be some restrictions in certain situations, though.

Check with your insurance company to see what’s required to change beneficiaries.

What Is Estate Planning?

Estate planning is an overarching concept.

It involves planning for how your estate will be managed after you pass away.

In general, this encompasses all aspects of what happens to your assets and how you support your family after you die.

Most often, estate planning is thought of as having a will or trust, but it can be much more complex than that.

The estate planning decisions you make have several consequences.

One of the significant consequences many plans account for is the tax impacts of how money flows to your heirs.

This is particularly important for wealthy individuals.

Anyone that plans to pass on assets over the estate tax exemption should consider estate planning.

However, this group is relatively small. That’s because the estate tax allows you to exclude the first $11,700,000 you pass on to your heirs in 2021.

Some people attempt to take care of estate planning on their own.

They may purchase forms at an office supply store or off of a website.

Sadly, doing it yourself could cause problems if the estate planning isn’t done correctly.

At the same time, this may work for some people with simple situations.

Estate planning isn’t easy because each state has different laws.

General advice can be helpful, but specific advice about your situation is best.

For this reason, many people consult estate planning professionals, such as attornies, when taking care of this vital planning aspect.

These people charge for their time but many people feel it is worth the cost.

What Is a Will?

A will is a document that states how your assets will be passed on after you die.

Within the will, you name beneficiaries to receive parts of your estate.

You can divide your assets up in specific ways. You may bequeath family heirlooms to one person and cash held in a safe to another.

Alternatively, you can leave general instructions to divide assets equally among any living children.

You must also name an executor of the will. This person is in charge of distributing your assets according to your will.

Wills may end up going through probate. This is a process where the court system signs off on the will and distribution of assets after you die.

This process can vary from state to state, but it takes time and likely costs money due to court costs.

Some estates may be exempt from probate if they fall under a certain dollar amount.

Wills won’t control how all of your assets are distributed, though.

Some accounts, such as retirement accounts, may require you to make a beneficiary designation.

This tells the institution who to give the assets in the account to when you die.

If those beneficiaries are alive at the time of your death, these assets likely skip probate and go straight to the beneficiary.

If the beneficiaries are dead, the money in these accounts or products will likely go to your estate and be handled through your will and probate.

What Is a Trust?

A trust is an estate planning tool you can use to attempt to avoid probate.

When you create a trust, you put assets into that trust rather than owning them yourself.

These assets could include money, homes, and any other assets you wish.

You can even make trusts the beneficiary of your life insurance policy in many cases.

The trust is then managed by a third party you designate. This person is called a trustee.

When you create a trust, you also create a trust document.

The document specifies many important factors, including:

  • What type of trust you have
  • Who the trustee is
  • How the trust will be managed
  • Who assets will be distributed to
  • When assets will be distributed
  • How assets will be distributed

Several types of trusts exist. You can manage a revocable trust yourself.

This should allow your assets to skip probate when you die, but it won’t let your estate skip paying any estate taxes it must pay.

An irrevocable trust must be managed by a third-party trustee and cannot be changed by you after it is created.

These trusts may allow your estate to skip paying estate taxes if properly managed.

Wealthy individuals may want to consider an irrevocable life insurance trust, too.

As you can imagine, trusts can be complex.

If a trust sounds like something you want to enact, you should work with a professional to create a trust that meets your needs.

How These Aspects Work Together

Life insurance, wills and trusts can all work together as part of your estate plan.

It’s essential to understand how these pieces work together, though.

First, life insurance death benefits generally won’t be paid out according to your will.

As part of setting up a life insurance policy, you designate beneficiaries.

The death benefit from the life insurance policy should be paid to those beneficiaries outside of the wishes of your will or the probate process as long as those beneficiaries are alive.

If the beneficiaries pass away before you do, you could run into issues.

Thankfully, you should be able to update your beneficiaries in most cases by contacting your life insurance company.

If you don’t, the life insurance benefits will likely get paid to your estate as the beneficiary.

Then, it will be distributed according to your will. In many cases, this means going through probate.

This works very similarly to the retirement account example mentioned above.

You can also have these estate planning tools work together in other ways.

For instance, you could set up a trust. Then, you can name the trust the beneficiary of your life insurance policy.

As long as the trust stays in effect, the death benefit should be paid to the trust.

Then, the money can be distributed according to the parameters of the trust.

Consult a Professional

As you can tell, estate planning can get complicated quickly.

Depending on your circumstances, you may want a life insurance policy, will and trust.

Once you start setting up a will or trust, it is imperative to get professional legal help.

Understanding exactly how your estate will pass on is important to many people.

Online documents can help you set up a basic will or trust, but you don’t know all of the rules.

Each state has different laws that may allow or disallow certain things.

This means:

You won’t know if your assets will pass down to your beneficiaries or heirs as you would hope.

If you read the forms wrong or they don’t comply with your state’s laws, they may not be valid.

Even worse, something unintentional could happen that results in the wrong person getting your assets.

An estate planning professional can help you set up your estate planning documents accurately from the beginning.

Then, you can return to that professional as your life changes to have any necessary adjustments made.

These professionals can advise you on how to designate beneficiaries on your life insurance policy to have the money pass down to the people who need it when you want them to have it.

They may do this by setting up a trust or through other methods.

The critical thing to remember is they’ll give you customized advice based on your situation and desires.