Life Insurance: Should it Be a Trust Asset?

Adam and Betty wanted to make their estate settlement simple for each other and for their two kids. Knowing that assets in their own individual names would have to go through a court proceeding called probate, they created a revocable living trust and transferred their stock, home, LLCs into their trust.  They wanted to avoid lawyers, judges and courtrooms. 

Adam and Betty had heard that life insurance policies, IRAs, 401-Ks and annuities automatically avoid probate by their very nature because they are paid to the account’s beneficiary.  So, they didn’t transfer their life insurance policies to the trust.  Adam passed away. The insurance company immediately tells Betty that the insurance company needs a court order from the probate court. What?

Because life insurance agents used to believe that there would be some estate tax savings, the insurance agents would write the insurance applications in a way that the husband would own the life insurance policy on the life of the wife, and the wife would own the policy on the life of the husband.

So, when Adam died, it was determined that Adam owned the policy on Betty's life. When Betty dies, the death benefit will be payable to Adam (or Adam's estate). In either case, Adam's probate is necessary to collect the death benefit when Betty dies. In addition, if the policy that Adam owns has cash value, Betty will not be able to access this cash value until the policy’s ownership gets transferred by the probate court proceeding.

Had they transferred their life insurance policies to their trust prior to Adam's death, probate would not have been necessary. After Adam died, Betty, as the sole trustee, would have been able to access the policy’s cash value or change the beneficiary. But since they assumed that life insurance avoided probate, they ended up being required to complete Adam's probate to correct the life insurance problem, even though all of their remaining assets avoided probate.

If you would like to review your life insurance policy ownership and determine your best options, contact us at 214.220.2130 for an appointment.