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How Does Life Insurance Create an Immediate Estate?
How does life insurance create an immediate estate? By providing a lump sum of cash to your beneficiary (or beneficiaries) upon your death with no legal wrangling or red-tape. There’s simply no other financial product that can do that. Let’s dive into the details.
How Does Life Insurance Create an Immediate Estate?
But first, let’s back up a step to explain how this works, starting with what makes up your estate.
An “estate” is everything that makes up your net worth. That includes real estate, any cash in your bank account, stocks or retirement accounts, all the possessions you have, and any other assets you own in full or part (cars, boats, businesses, timeshares, etc.). Your estate also includes your life insurance policy’s death benefit payout.
So even if you leave behind absolutely nothing but your life insurance money, that’s still an “estate.” And it starts the moment your policy goes in force, which is why it’s often referred to as an “immediate estate.”
Life Insurance: The Best Way to Leave Someone Money
Okay, now you know the answer to the question “how does life insurance create an immediate estate?”
But there’s a lot more going on than just creating an estate.
Life insurance is the fastest and easiest way to leave someone money when you pass away. That’s because, unlike a will, life insurance is not subject to government red-tape. To see the difference, let’s take a look at the process of leaving someone money from two perspectives: a will vs. life insurance.
What Happens When You Leave Someone Money in a Will?
If you create a will to leave your loved ones money (or other specific bequests), here’s what happens when you pass away.
First, your executor – who must be named in the will – will file a copy of your will with the court, among other things. Every will must then be authenticated and analyzed by a court in a process called “probate.” If you have lots of debt, some or all of your estate may need to be liquidated to pay those debts before anything left over can be distributed to the people named in your will. The court will oversee your executor in clearing that debt.
Probate can be incredibly drawn-out and time-consuming. Even if the judge sees no problems with the will and you have no debt, the court’s busy schedule often means a will won’t clear probate for months after a person’s death. If there are questions or issues with the will, it can be tied up in probate for years. In other words, if you left someone a gift of money in your will, it could literally take years for them to get it. And that’s if no one contests the will – which creates another legal process that only extends the time, effort, and legal fees required from everyone involved.
To sum up, there are several problems inherent in leaving money via a will:
- The amounts left behind are subject to debt collectors. Their claims will be heard and dealt with before your loved ones get what’s left of your estate.
- The amounts left behind are subject to a judge’s review during probate. If, for example, you owe child support when you die, that money can be taken from your estate.
- Anyone contesting the will can draw the process out. If, for example, a close relative feels left out, they could contest your will and make a case that some of your estate should go to them. Do your loved ones have the money, time, and energy for a court battle?
Now you can see why people online ask, “how does life insurance create an immediate estate?” They simply want a faster, better way to leave money to their loved ones.
What Happens When You Leave Someone Money via Life Insurance?
As an alternative to the drawn-out process above, you can create an immediate estate for a loved one using life insurance. Here’s how it works.
As part of the life insurance application process, you choose one or more beneficiaries to receive the death benefit. It’s up to you how many people (or organizations) you select, as well as what percentage of the total amount they’ll receive. For example, if you have a spouse and two adult children, you could leave 50% of the death benefit to your spouse, and 25% to each of your two children (for a total of 100%).
Once the application process is complete, you’ll make your first payment – and that’s what puts the policy “in force,” in insurance speak. Your policy is a contract between you and the insurance company. You fulfill your end of the deal by continuing to make your payments. At any time before you die, you can change your beneficiaries and their payout percentages. Then, when you pass away, the insurance company fulfills their end of the deal by paying your beneficiaries’ claims.
Because life insurance is a purchased product, it’s not the same as a will and is not subject to probate. There is no waiting period and no possibility that the money could be diverted to someone else, including people or companies you own money to. The payment of that money is the fulfillment of a contract. You paid the insurance company to give that money to the person or people of your choosing, and it is obligated to fulfill that contact.
Benefits of Life Insurance in Estate Planning
Okay, so now you know how the process works. And as you can see, there are a lot of benefits to using life insurance in estate planning.
Here are the most important points to consider:
- Guaranteed payout. Life insurance is a contract that is guaranteed to pay out when you pass away. Most insurers pay claims within 30 days of your beneficiary’s claim; payments can often be dispersed in as little as 1-2 weeks.
- Free from probate. Your beneficiaries do not have to deal with the hassle or delays of probate in order to get their payout. All your beneficiaries have to do is provide the insurer with a copy of your death certificate and fill out a claim form.
- Free from debt collectors. As long as at least one of your named beneficiaries is alive when you pass away, debt collectors cannot access the death benefit. The only way debt collectors could make a claim on that money is if: (a) all your beneficiaries died before you and you did not update your beneficiary designations, or (b) you named your estate as a beneficiary. These are special cases, however. As long as you name real people (not your estate) and keep those choices up-to-date, your life insurance company is only allowed to pay the death benefit to the people you named.
- Income tax-free. In almost all cases, your beneficiary will not have to pay income tax on the cash payout. For more information, check out our post on how life insurance can help you avoid tax liability.
At this point, you can see how it pays to know the answer to the question “how does life insurance create an immediate estate?” The benefits are significant and lasting, from skipping probate to saving your loved ones from the burden of extra income tax.
One Caveat: Estate Tax Threshold
There’s one important point to watch out for when it comes to life insurance and taxation. If you have a high net worth, it’s possible your life insurance death benefit could raise the value of your estate enough to trigger estate tax.
As of 2023, the IRS’s estate tax threshold is $12.92 million.
As insurance advisors, we have suggestions for how you can use life insurance in estate planning without triggering estate tax. If you’re in this situation, please give us a call at (800) 521-7873 and we’ll go over customized insurance solutions that meet your needs.
Summary
Okay, let’s recap: how does life insurance create an immediate estate? Your policy’s death benefit is added to the sum total of your estate the minute your policy goes in force. If you want to leave an estate behind but have no assets, a life insurance policy creates that legacy instantly. In addition, life insurance payments are income-tax-free and not subject to probate. That’s what makes life insurance the easiest way to transfer money between generations.
