How to Claim and Use Life Insurance

Many people have life insurance, and they have it for a multitude of reasons.  These include funeral costs, liquidity in an estate, help paying off taxes and so on.  Whatever your reason for having it, I wanted to talk about how to make a claim on it, and separately, what to do with it once you have.  You can see more at Kiplinger’s recent article entitled “What Is the Best Way for a Widow to Use Life Insurance Proceeds?”

When making a claim, you’ll need a couple of things.  First and foremost, perhaps blindly obvious, is that your beneficiaries need to know you have it.  If an insurance company becomes aware of a death they might reach out to named beneficiaries, but that is a big assumption.  So, your life insurance beneficiaries or whoever may claim the insurance needs to know it exists.

Holding that aside, the person entitled to the money will start by contacting the insurance company.  The company will send or direct that person on where to download a form to claim the insurance.  Beneficiaries typically need to provide proof of who they are, a death certificate for the insured (which in most places is issued within a few weeks of death) and other information about how to pay the insurance.  For example, some companies ask if you want to turn it into an investment fund at their financial institution, others arrange how to cut the check and so on.

It is worth noting that your executor or trustee won’t have the right to do this unless the estate or the trust is the beneficiary of the life insurance.  All told, the process typically takes something like 30 days.

Now, what to do with the insurance proceeds varies based upon the purpose and need of the life insurance.  I’m also going to assume for now that the insurance isn’t being paid to a trust which is designed to hold assets long term such as a descendant’s trusts.  That might have different concerns.

So, with that said, here are some ideas on how to use the life insurance.

Funeral Costs. Use life insurance money to cover these costs to decrease your financial strain.  Most funeral companies actually have you purchase a small insurance policy in order to prepay a funeral.

Ongoing Expenses. This is especially true when one spouse dies, but living expenses do not stop. Your income is frequently reduced. In fact, after the death of a spouse, household income generally declines by about 40% due to changes in Social Security benefits, spouse’s retirement income and earnings. The death benefit from a life insurance policy can help provide the funds you need to help cover your mortgage, car payment, utilities, food, clothing and health care premiums.

Debts. You are generally not personally responsible for paying off the debts of the decedent. However, when an estate does not have enough funds to pay all the debts, any gifts that were supposed to be paid out to beneficiaries will most likely be reduced. Note that you may be responsible for certain types of debt, such as debt that is jointly owned or a loan that you have co-signed. Talk to an experienced estate attorney to understand the laws of your state, so that you know where you stand concerning all debts.  By way of example, you have very few responsibilities to pay a decedent’s debts in Texas.

Taxes.  As a tie-in to debts, some people use life insurance to give an influx of liquidity to pay estate taxes.  This often helps when an estate is large due to real estate or businesses or other illiquid assets.  The IRS of course wants the tax paid in cash, so life insurance gives you the cash to do so without liquidating other assets.

Create an Emergency Fund. Life insurance can help build a liquid emergency fund, which should cover three to six months of expenses.

Supplement Your Retirement. When one spouse passes, the survivor becomes much more economically vulnerable. To retire, a person typically needs 80% of their preretirement income to live comfortably.  So, insurance provides and extra supplement to cover that need.

Reference: Kiplinger (Dec. 17, 2021) “What Is the Best Way for a Widow to Use Life Insurance Proceeds?”

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Update on Estate and Gift Taxes for 2022

There was a lot of discussion last year about potential changes to the federal estate and gift tax laws.  It’s possible that some of these proposals may be enacted in 2022, but for now, none of them have passed.  In the meantime, exemptions have increased for inflation, giving taxpayers a chance to lock in rates and exemptions before the federal estate tax sunsets to $5 million and some “change” for inflation. You can see a fuller explanation in the recent article, “2022 Transfer Tax Update,” from Forbes.

For now, the increased estate and gift tax exemptions are:

  • In 2022, $12,060,000 federal estate tax exemption, with a 40% top federal estate tax rate.
  • $12,060,000 GST tax exemption and a 40% top federal GST tax rate.
  • The lifetime gift tax exemption is now $12,060,000; with a 40% top federal gift tax rate.
  • The annual gift tax exclusion for 2022 increases to $16,000.

The IRS and the Treasury Department have both stated they will not attempt any claw-backs from gifts given between 2018—2025 for a taxpayer who dies in 2026 or beyond, when the exemptions return to the $5 million mark under the 2012 Act.

The opportunity to take advantage of these exemptions is now. A variety of estate planning techniques are still available to address estate and gift tax. Shifting income-producing assets to individuals in lower income tax brackets or who live in states with no or lower income taxes may be appropriate.  It might make sense to make substantial gifts in 2022, but that will be a case by case analysis.  You can see this past article discussing that more, although it should be tempered by the current tax picture: https://galligan-law.com/gifting-and-estate-taxes/  

Does this mean your estate plan needs to be revised? If you’re like most people, your estate plan is relatively flexible. However, if you haven’t reviewed or revised your estate plan in two or three years, it’s time to make an appointment with your estate planning attorney. There have been many changes in the law in recent years, and chances are, changes in your life since the last time your plan was reviewed.

The GST tax is not portable on the death of a spouse. Certain states (including New York, Connecticut, and Massachusetts) don’t permit estate tax exemption portability. A bypass trust may be the solution.

The gift tax annual exclusion amount has increased to $16,000 for individuals ($32,000 by married couples). It may be better to gift securities of interests in privately held companies or other family entities. Assets gifted now may be worth less than they were previously, and if they increase in the future, you’ve created a built-in discount.

Talk with your estate planning attorney to make the most out of these tax situations before they go away.

Reference: Forbes (Jan. 4, 2022) “2022 Transfer Tax Update”

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What is an Estate Asset?

Estate planning attorneys are often asked if a particular asset will be included in an estate, from life insurance and real estate to employment contracts and Health Savings Accounts. The answer is explored in the aptly-titled article, “Will It (My Home, My Life Insurance, Etc.) Be in My Estate?” from Kiplinger.

When you die, your estate is defined in different ways for different planning purposes. For example, you have a gross estate for federal estate taxes which defines all of the assets subject to the tax. However, there’s also the probate estate, which means property controlled by a will, and a non-probate estate, which means property passing outside of probate and the will.  So, if you are asking if an asset is part of an estate, it depends on which “estate” you mean.

Let’s start with life insurance. You’ve purchased a policy for $500,000, with your son as the designated beneficiary. If you own the policy, the entire $500,000 death benefit will be included in your gross estate for federal estate tax purposes. If your estate is big enough ($12.06 million in 2022), the entire death benefit above the exemption is subject to a 40% federal estate tax.

However, if you want to know if the policy will be included in your probate estate, the answer is no. Proceeds from life insurance policies are not subject to probate, since the death benefit passes by contract directly to the beneficiaries.  An executor or administrator of your estate never controls or has access to it.

Next, is the policy an estate asset available for beneficiaries of your probate estate?  So, let’s assume you left a will and your son is the named executor.  The will names all three of your children as equal beneficiaries.  Because the life insurance bypassed the probate process and went to a named beneficiary, none of the life insurance is available to the other two children.  If you wanted the money to go in trust for a beneficiary under the will, fund charitable giving or specific bequests, then the life insurance proceeds aren’t available for those purposes.

As an aside, common probate assets may include real property, tangible property like household contents, vehicles and so on, bank accounts depending on titling, and miscellaneous refunds due to the decedent.  Common non-probate assets may include life insurance, retirement funds and accounts with beneficiary designations generally.

Another aspect of figuring out what’s included in your estate depends upon where you live. In community property states—Arizona, California, Idaho, Louisiana, New Mexico, Nevada, Texas, Washington, and Wisconsin—assets are treated differently for estate tax purposes than in states with what’s known as “common law” for married couples. Also, in most states, real estate owned on a fee simple basis is simply transferred on death through the probate estate, while in other states, an alternative exists where a transfer on death deed or similar technique is available.

It is also true that certain states expect executors to have information about non-probate assets.  For example, New York has estate tax and Pennsylvania has inheritance tax.  Both states require an executor to file the appropriate return that will include information about non-probate assets because they are subject to tax (similar to the federal estate tax) even though the executor doesn’t take control of them.  Texas, you’ll be happy to know, does not have an estate or inheritance tax.

Speak with an experienced estate planning attorney in your state of residence to know what assets are included in your federal estate, what are part of your probate estate, and how taxes and creditors will apply to these various assets.

Reference: Kiplinger (Dec. 13, 2021) “Will It (My Home, My Life Insurance, Etc.) Be in My Estate?”

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