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Do Life Insurance Proceeds Go Through Probate?

Tuesday, March 12, 2024

The legal process of dividing and transferring ownership of inherited assets in the case of someone’s death is called probate.

In probate, a court official reviews the estate, seeks to follow the deceased’s will (if applicable), and settles any outstanding debt while distributing assets to beneficiaries. In many cases, an executor – such as a family member – is chosen or appointed to handle the last affairs.   

However, not every asset or group of assets in an estate will go through probate. In this article, we’ll look at how life insurance and probate intersect. We’ll answer questions like:

  • What happens when a life insurance policy owner dies?
  • Do life insurance proceeds go through probate?
  • Does a life insurance beneficiary override a will?
  • How do I keep life insurance proceeds out of my estate?
An old and a young person sit together.

The Intersection of Life Insurance & Probate

If you’re new to life insurance, looking to purchase a policy, or simply want to organize your assets, it’s worthwhile to understand how probate works and learn how to prepare so your loved ones can save time and money.

Your estate might include a term life insurance policy to cover funeral costs and provide financial support to your family, or permanent life insurance placed in a trust fund. In each case, it’s important to know how probate (and related estate tax) will affect your investments.  

Probate laws vary by state and the process generally is simplest when there’s a comprehensive will or an irrevocable trust, and no dispute among potential heirs. Is life insurance part of probate? Not necessarily. It’s not required that life insurance proceeds go through probate upon someone’s death, but there are exceptions and you may need to update your estate paperwork to ensure life insurance payouts are streamlined in the future.

We’ll address common scenarios and pitfalls to look for in this article. First, let’s go over a few basic terms related to probate, life insurance, and financial planning. 

  • Life Insurance: Term policies last a set number of years and make payment to a beneficiary when the insured person dies – only if the policy is active. Permanent policies are more complicated, more expensive, and generally are used to build and transfer wealth on a tax-free basis.  
  • Estate Tax: Beneficiaries (spouses excepted) may have to pay federal taxes if the estate value exceeds IRS thresholds. Some states have lower limits, which can trigger tax on your estate.
  • Beneficiary: The person named on estate paperwork, in a will, or on a life insurance policy as the designee to receive funds or assets.

With these definitions in mind, let’s dive into the issues at play. Remember, we’re proud to be your chosen life insurance agent but we are not lawyers. If you’re experiencing legal difficulty related to life insurance proceeds, please consult a probate or will-contest attorney.

What Happens When a Life Insurance Policy Owner Dies?

Life insurance is designed to provide some financial security to your family or loved ones when you die. 

Unlike other assets subject to probate – such as real estate – life insurance proceeds are typically considered non-probate assets. This means the funds are directly payable to the designated beneficiaries upon the policyholder’s death, without the need for court intervention.

Provided the life insurance policy is active and the insured meets the terms of coverage, a beneficiary will be paid the value of the policy’s death benefit. 

But if there’s no specified person (or organization) as the beneficiary on the life insurance policy when the owner dies, the asset goes to probate. 

life insurance explained

Life Insurance Probate Exceptions

With estate settlement, pre-planning and clarity of intent is paramount. Probate will sort out any unsettled assets upon death but the process involves more taxes, attorney fees, and longer wait times.

In most cases, you can avoid life insurance proceeds landing in court. But, here are three common scenarios that will trigger life insurance benefits to go through probate. 

  1. The estate is named beneficiary: If you need an alternative from an individual beneficiary, it’s usually best to set up a trust instead. If life insurance proceeds are directed to the estate, the funds will be subject to creditor claims and probate. 
  1. The beneficiary is blank: It’s easy to add a person or organization as a beneficiary but sometimes policyholders forget. In this case, probate will be necessary.
  1. The beneficiary has died: Naming a contingent (or backup) beneficiary will address this issue. If you don’t, some states will issue the asset to the heir of the original beneficiary during probate. Probate rules for this situation will differ based on jurisdiction.

How Do I Keep Life Insurance Proceeds Out of My Estate?

If life insurance proceeds aren’t paid directly to beneficiaries, the asset may be subject to estate tax following probate decisions if the overall estate exceeds tax-free thresholds.

The simplest assurance to avoid probate comes by naming a living beneficiary on your life insurance policy – and updating the paperwork if circumstances change. Adding more than one beneficiary (with allowable varying percentages) or a backup beneficiary can be helpful, too. 

If you’re undecided, consider directing the life insurance proceeds to a trust, set up to benefit your loved ones or another organization.

Benefits of Avoiding Probate for Life Insurance

Because your life insurance benefits are meant to be helpful to your loved ones, it makes sense you’d want the process to be smooth and easy for them. The key benefits to keeping life insurance proceeds free of legal limbo are:

  • Timeliness: If your life insurance benefits are meant to cover funeral costs, this has clear implications. Bypassing probate typically means the funds will be dispersed much more quickly to the beneficiary.
  • Saves money: Court comes with all sorts of fees and expenses, including executor commission. Plus, if your assets are particularly large, the extra life insurance funds could trigger estate tax.
  • Free of debt: Life insurance proceeds outside probate are typically protected from creditors, ensuring that beneficiaries receive the full benefit without interference from outstanding debts or obligations.
  • Protection of privacy: Probate proceedings are a matter of public record, potentially exposing sensitive financial information and family matters to public scrutiny. 
A calculator, a pair of glasses, and a pen sit atop a paper reading "Life Insurance Policy."

Does a Life Insurance Beneficiary Override a Will?

If the named beneficiary is alive and willing to accept the life insurance payout, then no – a will does not supersede the listed beneficiary on the policy.

If a beneficiary is unclear or has died with no contingent beneficiary listed on the policy, the asset will be included in probate proceedings. At this point, a person’s will is important as the executor may find eligible beneficiaries (or creditors) who have a right to the life insurance proceeds.

Probate Rules for Life Insurance By State

State laws play a significant role in shaping the probate process for life insurance proceeds. In South Carolina, for example, several considerations may affect the probate process for life insurance proceeds:

  • Community Property Laws: South Carolina is not a community property state, meaning that assets acquired during marriage are generally considered separate property rather than jointly owned. However, specific rules may apply to jointly owned life insurance policies or policies purchased with previously-married couples’ funds.
  • Estate Tax Laws: South Carolina does not impose estate tax but an executor may need to pay income tax on commission payments. And federal estate tax laws still apply. Assets in other states may be subject to estate tax.
  • Debt Obligations: If life insurance funds are tied up in probate and creditors are eligible, the money may be used to pay debts. Every state has a different set of rules for paying back debt from an estate. Administrative costs, taxes, and medical debt take precedence in South Carolina.

Once you understand the implications of probate, consult with your insurer to check that your policy beneficiary listing is clear and up-to-date. At Independent Insurance Associates, we carefully consult with clients to make sure your investment and life insurance benefits provide the intended peace of mind for your loved ones. We’ll listen to your needs and goals and help you make an informed decision – whether you’re looking for basic coverage or want to obtain a life insurance policy. Call us today to get started!