Most people own life insurance that is payable to a third party. It is customary to name your spouse as the beneficiary, with your children being contingent beneficiaries in equal shares. Conversely however, there are benefits to not owning life insurance at all.
Any life insurance that you own is included in your estate for estate tax purposes, regardless of whom the beneficiary is. Naturally, there is no tax between spouses, as there is an unlimited marital deduction for all assets passed to the surviving spouse. However, if your spouse predeceases you, then the death benefit, not the face amount of the policy, will be includable in your estate for estate tax purposes. This may cause a significant tax problem in that a whole life policy or a term life policy (which has no cash value,) has a significant value upon death. The total death benefit received by the beneficiary is normally income tax free, but there is a tax based on the total value of the estate of the decedent/owner.
The key to reducing these taxes is this: If any other party owns the policy for a period of three years prior to your death, and if certain technical requirements have been met, the policy proceeds will not be estate taxable upon your death. In a case where there is a significant amount of life insurance, it is normally recommended that either your children own the policies, or in the alternative, an irrevocable trust own them.
In some policies it is also possible to name a contingent owner. This may be important in a situation where a policy owner, such as a spouse, predeceases the other spouse. Rather than having the policy revert back to the surviving spouse, which will be a part of his/her estate, the decedent could nominate a trust or his/her children to be the contingent owners of the policy. Since the spouse’s policy does not pay off any proceeds until his/her death, he/she has already relinquished control of it, and it is highly unlikely that he/she will care about regaining possession of the policy since the proceeds are only going to be payable to the children upon death.
Likewise, it is very important to consider the beneficiary and contingent beneficiary of a policy. If your spouse is named as the first beneficiary and there is no contingent beneficiary appointed, then his or her death results in no beneficiary at all. As a result of this circumstance, proceeds will normally pass through as dictated by your Will. If no Will exists, then proceeds will pass by the laws of intestacy to the heirs-at-law who are entitled to receive your assets.
Again, life insurance is normally established so that it will pass without the need for probate, but when your beneficiary predeceases you, unless you change the designation, the proceeds will pass through probate court. A problem may come into play if your spouse is incapacitated to the extent that he or she is unable to make informed decisions. In this case, the beneficiary form may not be adjusted, and unfortunately, even his/her power of attorney or guardian will not have the specific authority to change the beneficiary designation without a special court order.
Therefore, when purchasing an insurance policy or upon reviewing an estate plan, it is important to review the owners, contingent owners, beneficiaries, and contingent beneficiaries of the policy. In most cases, there is no fee or cost to contact the agent serving the policy to re-determine the appropriate parties to the contract.
By: Hyman G. Darling, Esquire
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