Naming your estate as beneficiary of a life insurance policy

INTRODUCTION

There are generally two ways that a life insurance policy could become payable to the estate of a deceased person. The first is if a person actively names their estate as the beneficiary. The second is if no named beneficiary is alive to receive it.  In either case a probate will likely be the result!

ACTIVELY NAMING YOUR ESTATE AS BENEFICIARY

I have been an estate planning since 1994 and I really can’t think of a great reason to name your estate as the beneficiary of a life insurance policy. The only thing I can imagine would be the beneficiary you want to provide the policy to is a minor and you don’t have time or money to properly prepare an estate plan. Some policies have default provisions for beneficiaries if one isn’t named. Thus, if you fail to name any beneficiary it could be paid to your next of kin you don’t want. In most instances you would just actively name the person you do want to receive it. However, if they are minors paying it to your estate would probably be better than nothing. Even then it’s a stretch. Maybe if there is a minor beneficiary involved, you don’t have time to properly plan and you don’t want the minor’s parent involved!?  I don’t know. I am reaching here trying to justify why anybody would name their estate as beneficiary of a life insurance policy. Suffice it to say it’s not a good idea.

DEFAULT TO YOUR ESTATE WHEN NO LIVING BENEFICIARY

This is the much more common situation than the first above. This actually happens a fair amount. It comes up in two situations. The first is when someone just forgets to name a beneficiary. The second is when the named beneficiary has died before the person whose life insurance policy is involved. In either case the payment, if the company has no default provisions for next of kin, will pay to the estate. Thus a probate is the outcome.

DIRTY LITTLE SECRET

Actually, there is a third which I think is the dirty little secret of the life insurance industry. It’s the lost beneficiary designation forms. Let me start by saying I have no proof of this so it’s just my theory. I have had several cases over the years where someone has died with no named beneficiary. The family has been certain that their mom/dad/other had named a beneficiary. “They were so organized they would have had a beneficiary for sure.”  I even had one case where my client presented a copy of the beneficiary form and it had the received stamp from the life insurance company but they showed no record of it. My theory is that over the years life insurance companies went from paper forms to computer files. I think many beneficiaries were lost during this transition. Again, I have no actual proof and am not saying it was intentional but I think it happened.

OUTCOME

In any of the above situations a probate is likely. The issue becomes what is the total of the life insurance policy and what other assets are there. If the policy is the only asset subject to the probate laws then a full probate can be avoided if the total is less than $150,000. Note it is LESS than $150,000 so a policy of exactly $150,000 would not qualify. If less than $150,000 then a probate code 13100 small estate affidavit should work. If it’s $150,000 or more then you need to do a full probate.  There is one caveat that some people, who have a living trust, can qualify for a Heggstad petition to get the policy into the trust if there is no named beneficiary; but not if the estate is actively named by the decedent.

CONCLUSION

Name your beneficiaries right! Talk to your estate planning attorney. Talk to your financial adviser.  Generally speaking your trust or a responsible adult, or adults, should be directly named. Also, take the time to name contingent beneficiaries.  Most life insurance companies allow secondary back-ups too. Fill that space up with names because you never know!

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Does a life insurance beneficiary change by divorce?

How would you feel if your evil ex-husband or witch of an ex-wife received your life insurance after you die?  Talk about rolling over in your grave!?

Upon filing for divorce, in California, there are automatic restraining orders. Among them, you are not allowed to make changes to non-probate transfers without the consent of your soon to be ex-spouse. This means you can make a new will (since that’s a probate transfer) but you can not change your trust, IRA, 401k or life insurance beneficiary.

Yes, some people die during extended divorce proceedings and their not quite ex-spouse gets the asset. This is not the outcome many want but it’s often unavoidable. However, after the divorce is complete it is avoidable but you might have to take action!

Some beneficiary designations are automatically revoked, if they pay to the ex, by divorce.  Some are covered by federal ERISA law which is beyond the scope of this post and the rest are covered by California state law.  Many of these are governed by California probate code 5600 which provides as follows for nonprobate transfers after divorce (with my added emphasis):

5600. (a) Except as provided in subdivision (b), a nonprobate transfer to the transferor’s former spouse, in an instrument executed by the transferor before or during the marriage, fails if, at the time of the transferor’s death, the former spouse is not the transferor’s surviving spouse as defined in Section 78, as a result of the dissolution or annulment of the marriage. A judgment of legal separation that does not terminate the status of husband and wife is not a dissolution for purposes of this section.
(b) Subdivision (a) does not cause a nonprobate transfer to fail in any of the following cases:
(1) The nonprobate transfer is not subject to revocation by the transferor at the time of the transferor’s death.
(2) There is clear and convincing evidence that the transferor intended to preserve the nonprobate transfer to the former spouse.
(3) A court order that the nonprobate transfer be maintained on behalf of the former spouse is in effect at the time of the transferor’s death.
(c) Where a nonprobate transfer fails by operation of this section, the instrument making the nonprobate transfer shall be treated as it would if the former spouse failed to survive the transferor.
(d) Nothing in this section affects the rights of a subsequent purchaser or encumbrancer for value in good faith who relies on the apparent failure of a nonprobate transfer under this section or who lacks knowledge of the failure of a nonprobate transfer under this section.
(e) As used in this section, “nonprobate transfer” means a provision, other than a provision of a life insurance policy, of either of the following types:
(1) A provision of a type described in Section 5000.
(2) A provision in an instrument that operates on death, other than a will, conferring a power of appointment or naming a trustee.

At first blush PC 5600 seems pretty clear, right? It says nonprobate transfers, executed during marriage, are invalid after divorce. What could be more plain, right?  I mean I know life insurance is a nonprobate transfer so it’s covered I think….  However, then you get all the way down to subpart (e) and that’s a game changer for life insurance because it says, and I do paraphrase, “oh ya, never mind what we said above because this section does NOT apply to life insurance.”

So… hey, I am not done yet! I know a few of you are now contacting your life insurance agent just to make sure and that’s probably the right thing to do but let me finish!

Seriously though, take this as an opportunity to check ALL your payable on death beneficiary designations. Life insurance, annuities, 401ks, IRAs, last pay checks, bank accounts and any other assets that allow for a POA or payable on death. Many are changed, automatically, by divorce by many are not. Plus, even the ones that are automatically revoked could create a fight after death. Thus better to get it straight now while you are alive!

- John Palley

Joint account ownership

What’s better joint account ownership or trust account ownership? Different account titling is better for different people in different situations.  However, in most cases ownership in the trust is the most flexible and long last answer.  For example, I was talking to a client last week who has a trust. Her adult son is co-trustee with her on the trust. She told me she was opening a new bank account and would name her son as payable on death on that account. I said, ok but what about signing checks NOW?  I told her that a “bank power of attorney” is a good option but can be difficult to arrange at some banks.  She said she would do joint ownership or joint tenancy then. I said that was fine but what if something happened to her son? What if her son had creditor issues?  What if, what if, what if….  The end result was I suggested she put the account in her trust. She already has the trust set up, her son is already co-trustee and thus the trust is the best solution. No attorney fees involved since it’s already set up, less bank forms, and good flexibility!

Simple “Advanced” Estate Planning

As I stated yesterday some advanced estate planning techniques are over-used in that they are overly complex for a lot of people.  In addition they cause recurring costs.

There are two advanced estate planning tools that are under-utilized in my opinion.  The two are: 1) The Qualified Personal Residence Trust and 2) The Irrevocable Life Insurance Trust.

I have blogged about both of these before and would love to provide YOU more information but in short the two devices work as follows.

QUALIFIED PERSONAL RESIDENCE TRUST (QPRT) – An irrevocable trust that holds your house. It provides estate tax savings and maybe more importantly it provides creditor protection. It’s simple to set up and not that costly. There are no on-going costs.

IRREVOCABLE LIFE INSURANCE TRUST (ILIT) – An irrevocable trust that holds a life insurance policy for the benefit of your spouse and children (typically).  There can be huge tax benefits but even more importantly you can create incredible creditor protection for your loved ones.

Of course you should use a qualified California estate planning lawyer to set up your QPRT or ILIT.

 

Top 10 Estate Planning Mistakes

As a California estate planning and probate attorney I see both sides.  I see the planning process and I see what happens, after death, when the planning wasn’t done right.  Here is a top 10 list of estate planning mistakes:

10. Name your estate the beneficiary on your IRA, 401k, and other retirement plans. This is a great way of creating unnecessary tax and probate fees and costs. It also will delay the time when your family will have access to the money.  Attorneys and the tax man will love you for it! Your family won’t be so happy with you though!

9. Name your estate the beneficiary on life insurance.  Similar to above it creates unnecessary delay in access to the money and causes costs and fees.  Your family won’t love you for this.

8. Name no beneficiary on your 401k and other retirement plan.  In some cases the money will flow to your estate and create taxes, fees and costs as indicated at #10 above. However, some plans have a written list of heirs if no beneficiary is named and that list might be different than who you want to give the assets to!

7. Leave money to minor children or to your estate.  By doing this your kids will get your money when they turn 18. They will love you!  Also, the new car salesmen, car stereo salesmen, many other salesmen and also all of their friends will love you!  Plus, your kids will love you for the 6 months it takes them to burn through your money.

6. Outsmart the tax man and add your kids onto your house as a joint tenant.  Sure you might avoid attorney fees for a living trust but you might create a capital gains tax at death due to losing the full step up in basis. The IRS will love you for paying unnecessary tax.

5. If you have a safe deposit box don’t tell anybody about it. Just leave the key.  The family will love the treasure hunt going bank to bank throughout town looking for it. Of course, if you move to a new town before dying that treasure hunt is totally fruitless and they probably won’t be so happy with you.

4. Don’t fully fund your trust.  So many people go to the trouble and expense of creating a living trust but then they fail to put all the assets into their trust.  This creates unnecessary probate fees and costs.  Your attorney will love you!

3. If you re-finance your house do not put your house back into your trust. As above it creates an unnecessary probate and thus your family or loved ones will have to deal with the cost and delay of that. Again, your attorney will be appreciative!

2. Don’t use a certified specialist for your estate plan. It’s a great way of getting an inadequate estate plan. Sure you might, or might not, save a few bucks but….

1. Don’t have any written estate plan. It’s a sure way to cause problems and unnecessary money to be spent after death. If you want to really upset your family do nothing!

Really if you love your family avoid these 10 and hire a Certified Specialist in Estate Planning, Trust and Probate law as determined by the State Bar of California Board of Legal Specialization.  Contact me with your questions.  -John

Divorce and Life Insurance in California

I was contacted today by a client whose father just died. It was a painful death and, even more sad, he is probably now rolling over in his grave to learn what I am typing. He never changed the beneficiary on his life insurance policy and it goes to… his ex-wife.

Ughhhh. I am happy to not know exactly what it’s like to get divorced but I have heard enough stories and I know of few people who would want their life insurance to go to their ex.

California does have probate code 5600 (quoted below for your information) which seemingly indicates the distribution to the ex-wife would be stopped. That is in part (a) but part (e) says that these rules are not applicable to life insurance.

A good reminder to all is check your life insurance, 401k, IRA, and other death beneficiary designations. Don’t let your ex get a cent… unless you really want them to of course.

For more information about California wills, trusts, probate a

PROBATE CODE
SECTION 5600-5604

5600.  (a) Except as provided in subdivision (b), a nonprobate
transfer to the transferor's former spouse, in an instrument executed
by the transferor before or during the marriage, fails if, at the
time of the transferor's death, the former spouse is not the
transferor's surviving spouse as defined in Section 78, as a result
of the dissolution or annulment of the marriage. A judgment of legal
separation that does not terminate the status of husband and wife is
not a dissolution for purposes of this section.
   (b) Subdivision (a) does not cause a nonprobate transfer to fail
in any of the following cases:
   (1) The nonprobate transfer is not subject to revocation by the
transferor at the time of the transferor's death.
   (2) There is clear and convincing evidence that the transferor
intended to preserve the nonprobate transfer to the former spouse.
   (3) A court order that the nonprobate transfer be maintained on
behalf of the former spouse is in effect at the time of the
transferor's death.
   (c) Where a nonprobate transfer fails by operation of this
section, the instrument making the nonprobate transfer shall be
treated as it would if the former spouse failed to survive the
transferor.
   (d) Nothing in this section affects the rights of a subsequent
purchaser or encumbrancer for value in good faith who relies on the
apparent failure of a nonprobate transfer under this section or who
lacks knowledge of the failure of a nonprobate transfer under this
section.
   (e) As used in this section, "nonprobate transfer" means a
provision, other than a provision of a life insurance policy, of
either of the following types:
   (1) A provision of a type described in Section 5000.
   (2) A provision in an instrument that operates on death, other
than a will, conferring a power of appointment or naming a trustee.

Life Insurance Beneficiary – Trust or No?

Each asset you own has different issues when considering if it should be coordinated with your trust.  In my opinion life insurance is simple and there is one right answer… or at least one most correct answer. In my opinion the primary beneficiary of your life insurance policy should be your revocable trust in most cases.

Let me clarify there are times when your life insurance should not pay to your trust; most notably if there are estate tax issues when a different ownership arrangement has been made and secondly if you want to provide the life insurance to someone other than the beneficiary of your trust.  Putting those issues aside you should probably pay your life insurance to your trust.  Let me tell you why….

Let’s say you want your assets to go to your spouse when you die. You thus tell your attorney it would be easier to just pay it straight to her and, as a back up beneficiary you will name your trust. That’s acceptable but to me not the best. Simply put, what if your spouse is incapacitated?  In that case a conservatorship could be required in order for the life insurance money to be claimed.  Conservatorships, in California, can cost thousands and should be avoided whenever possible. Thus, even when your spouse is the primary beneficiary the trust should be the beneficiary of your life insurance. This assuming your spouse is also the primary beneficiary of your trust of course!

Another big mistake I see is when the life insurance is to benefit a minor. The payment of life insurance proceeds directly to a minor will create the need for a guardian ad litem to be appointed by the probate Court. This will cost thousands! Instead pay that money to your trust and put a clause in your trust to receive the funds and distribute to your minor beneficiaries.

Lastly, a lot of times your trust can create creditor protection for the people you leave the assets to. If the life insurance money gets paid outside of the trust that creditor protection element is most certainly lost.  Thus, it’s important the beneficiary does not “touch” the money but instead gets paid straight to the trust.

Certainly each case needs to be reviewed based on your individual situation but, in my opinion, it is desirable for most people to pay their life insurance to their trust rather than to an individual.

Call me to discuss YOUR case!

-John

ILIT's Do not Have to be About Estate Taxes

An ILIT is the standard acronym in the industry for Irrevocable Life Insurance Trust.  An ILIT is one of the most dynamic estate planning tools available and that’s why I mention them from time to time. The key on this blog post is the idea that an ILIT need not have anything to do with estate taxes.

Historically ILITs were used to create a tax free fund of money. With the current five million dollar ($5,000,000) exemption from federal estate taxes a lot less people are worried about estate taxes.  Of course the law is set to sunset December 31, 2012 and go back to ONE million dollars ($1,000,000) on January 1, 2013 but let’s put that concern aside for the moment. Let’s assume you do not have any estate tax concerns. Read on because this article will have a great idea to provide tremendous value to your family!

Let’s say you are a professional making a nice salary. Let’s say you have a husband and two young kids.  Like most people you want to provide for your husband and also your kids.  What if you could give them money tax free and with CREDITOR PROTECTION built in!?  Well, that’s what an ILIT can do for you and your family. The way it works is this….

Let’s say you want to provide a two million dollar death benefit to your family should you die prematurely.  Term life insurance, especially at young ages, can be purchased for pennies on the dollar.  I am not a life insurance salesperson but let’s assume you get two million dollars of term death benefit for $200/month. That’s a wild guess but let’s go with it.  Obviously the odds are in your favor that you will not die during the term of the term life insurance. Maybe it’s 10 or 20 years.  However, IF you die during that time your family will thank you forever for having the thoughtfulness of having two million dollars of death benefit. Even in today’s days of .002 percent interest most people can live decently with two mil in the bank!

Life insurance is often can distribute tax free after death but not always. There are many situations where it can create a taxable event. Thus proper planning is important. However, it can be made to be tax free with an ILIT if set up properly.

Ok, but why an ILIT?  An ILIT creates creditor protection for your spouse and kids. The two million would sit in an investment account, in the name of the trust, and in most cases the spouse can even be the trustee in charge of distributing assets! However, a properly drafted ILIT has built in asset protection so that their creditors can not get that money! It’s an incredible tool.  TAX FREE MONEY WITH CREDITOR PROTECTION BUILT IN!

The simple mechanics are you hire an attorney, like me, to set up an ILIT for you. The ILIT then purchases a life insurance policy (term or whole life) on your life. Each year you gift money to the ILIT trustee (usually a trusted friend) who pays the premiums of the life insurance. When you die the trustee claims the death benefit, invests it in the name of the ILIT, and then distributes the funds to the beneficiaries you have selected in the trust. It’s really simple!

The costs are not great to set up an ILIT and the combination of tax savings and creditor protection are truly PRICELESS!

Contact me to discuss your situation to see if an ILIT will help you!  -John