Quick Answers
If someone dies without a will, the life insurance policy proceeds will be paid to the named beneficiary. If there is no named beneficiary, it will go to the deceased’s estate and be distributed according to state intestacy laws. The life insurance company will require a copy of the death certificate and may require other documents before distributing the funds.
What is a Life Insurance Policy?
A life insurance policy is a contract with an insurance company. In exchange for premium payments, the insurance company agrees to pay out a lump sum of money known as the death benefit after the insured person passes away. This money can be used to pay final expenses or provide ongoing financial support to the deceased’s beneficiaries.
There are two main types of life insurance:
- Term life insurance provides coverage for a specified period of time, such as 10 or 20 years. It only pays out if the insured dies within the term.
- Permanent life insurance provides lifelong coverage as long as premiums are paid. It builds up cash value that the policyholder can access while still living.
The owner of the life insurance policy gets to name one or more beneficiaries – the person or people who will receive the death benefit. As long as premiums are paid, the named beneficiaries are guaranteed to receive the payout when the insured dies.
What Happens If There’s No Will?
If someone passes away without having a will in place, they are considered to have died intestate. Each state has intestacy laws that determine how assets like life insurance are distributed in the absence of a will.
If there is a named beneficiary on the life insurance policy, those individuals will receive the death benefit directly from the life insurance company. This happens outside of probate, which is the court-supervised process for distributing assets of an estate.
Having a named beneficiary makes the life insurance payout quicker and simpler for the beneficiaries to receive. The life insurance company will require a copy of the death certificate before distributing funds to the named beneficiaries.
No Beneficiary Named
Things get more complicated if there is no beneficiary named on the life insurance policy. In this case, the death benefit is paid into the deceased’s estate to be distributed according to intestacy laws.
The life insurance proceeds must go through probate in order for the estate administrator or executor to claim the funds on behalf of the estate. The administrator will need to provide the insurance company with documentation to claim the life insurance money.
The estate administrator will use the life insurance payout to settle any debts and taxes of the estate before distributing the remainder to heirs according to intestacy laws. This can be a lengthy process that keeps life insurance funds from reaching heirs for many months or even years.
Intestacy Laws Vary by State
Intestacy laws outline how assets in an estate without a will are distributed to surviving relatives of the deceased. The laws vary by state but tend to distribute assets in the following order:
- Surviving spouse
- Children
- Parents
- Siblings
- Extended family like grandparents, grandchildren, aunts/uncles, cousins
Some states have different intestacy guidelines based on whether children of the deceased are minors or adults. Community property states have provisions for splitting assets between a surviving spouse and children.
Life insurance is usually distributed outright to heirs rather than being held in ongoing trusts. However, state laws may require insurance funds to be used for minor children’s care and education before they reach adulthood and receive their share.
Example Intestacy Distribution
As an example, let’s look at how a $500,000 life insurance policy might be distributed if the deceased had:
- A surviving spouse but no children
- No surviving parents
- Two surviving siblings
In this case, the spouse would receive the entire $500,000 under intestacy law in most states. The siblings would not receive anything since the spouse is alive and inherits first.
However, the distribution would be very different if the deceased had a spouse + children and no siblings:
- Surviving spouse would receive 1/3 of $500,000 = $166,666
- Remaining 2/3 split equally among children = $166,666 each
The intestacy laws for most states are available online so you can review how your own state would distribute life insurance with no beneficiary or will in place.
Can Life Insurance Bypass Probate?
As noted earlier, having beneficiaries named on a life insurance policy allows the death benefit to bypass probate. The insurance company pays the funds directly to the named individuals, avoiding the delays and costs of probating the estate.
Besides naming beneficiaries, there are a couple other ways that life insurance can bypass probate:
Create a Revocable Living Trust
Setting up a revocable living trust and naming it as the beneficiary of your life insurance allows the death benefit to be paid directly into the trust. The trust distributes assets according to its terms, avoiding probate. This can be faster for beneficiaries to access funds.
Transfer Policy Ownership
Gifting or transferring ownership of a life insurance policy also keeps it out of probate. As long as the new owner names beneficiaries, the death benefit won’t need to go through probate. There may be potential gift tax issues to be aware of, however.
Special Rules for Married Couples
There are some additional considerations around life insurance distribution when the deceased was married:
Community Property
In community property states, a surviving spouse may be entitled to half or a portion of life insurance proceeds even if they were not named as a beneficiary. State law grants spouses joint ownership of assets acquired during a marriage.
Elective Share
Most states have laws allowing a surviving spouse to take an elective share of the deceased spouse’s estate, even if they were left out of the will. This elective share is often 30% to 50% of the total estate.
Life insurance paid to a named beneficiary usually does not count toward the estate total. But if the policy is paid to the estate, the surviving spouse’s elective share may apply to those proceeds.
Premiums Paid with Marital Property
If life insurance premiums were paid with marital assets like joint bank accounts, there is an argument that the surviving spouse is entitled to some portion of the death benefit. The share would be proportional to the amount of marital funds used over the total premiums.
Challenges to Life Insurance Distribution
While life insurance typically follows clear rules about distribution, there are some cases where the payout could be challenged:
Improper Beneficiary Designation
If there is evidence the deceased intended to change beneficiaries but did not submit proper documentation, it may be possible to challenge the payout. Courts can consider statements the policy owner made about their intended beneficiaries.
Policy Ownership Questions
If there is uncertainty around who rightfully owned the life insurance policy and had authority to name beneficiaries, distribution could be disputed. This might involve claims that the policy was marital property or that ownership was actually transferred.
Disputes Among Beneficiaries
If beneficiaries on a policy are vague (like “my children” without naming each one), there could be room for argument over who was entitled to receive funds. There can also be conflicts if multiple beneficiaries are named without clear percentage splits.
In some cases, a beneficiary might try to challenge the distribution because they feel their share should have been larger based on need or relationship to the deceased.
How to Avoid Disputes
To avoid potential fights or uncertainty about life insurance funds when you die, it’s best to take these steps:
- Name specific beneficiaries clearly on all your policies. Include full legal names, relationship to you, percentage splits if dividing among multiple beneficiaries.
- Specify contingency beneficiaries in case your primary beneficiary dies before you.
- Update beneficiaries promptly after major life events like marriage, divorce, birth of children, etc.
- Consider naming a trust as beneficiary to provide control over how funds are managed and distributed after your death.
- Keep detailed records of your policy documents and your intended beneficiaries.
- Let your beneficiaries and estate administrator know details about your policies so there won’t be surprises.
Taking these measures helps avoid situations where your life insurance gets paid to the wrong person or gets tied up in unexpected probate proceedings.
Should You Name Your Estate As Beneficiary?
Some people consider naming their own estate as the beneficiary of life insurance policies. Reasons may include:
- Wanting proceeds to be part of residual estate for heirs
- Concerns about a beneficiary properly managing lump sum payout
- Life insurance held in an irrevocable life insurance trust (ILIT)
However, there are downsides to paying life insurance to your estate:
- Requires probate process to distribute funds, delaying beneficiary access
- Your creditors could make claims against the death benefit
- Beneficiaries receive less after estate taxes and expenses are paid
Paying life insurance to your estate makes sense only in certain financial scenarios. It’s smart to consult an estate planning attorney before naming your estate as beneficiary.
Taxes on Life Insurance Payouts
In most cases, life insurance death benefits are not subject to income tax, whether paid to individual beneficiaries or an estate. Taxes would only apply in situations like:
- Policy is transferred and sold for cash before death
- You borrow against the policy’s cash value
- Death benefit exceeds estate tax exemption ($12.06 million in 2022)
Beneficiaries can choose to take a policy’s payout as a lump sum or in installments. If installments are selected, earnings would be taxed once they exceed the cost basis.
For large life insurance policies, beneficiaries should evaluate strategies to minimize taxes such as creating trusts. An estate planning attorney can advise on strategies to reduce tax liability on any inheritance.
Settling Debts with Life Insurance
If you die with outstanding debts, creditors may be able to file claims against your estate for repayment. Life insurance can provide funds to settle these debts so heirs receive their inheritance free of liens or collection actions.
Some tips on using life insurance to pay debts:
- Consider naming estate as beneficiary so proceeds are accessible to creditors
- Determine if debts like mortgage or student loans die with borrower – if so, insurance could go to heirs
- Weigh benefits of paying off debts vs maximizing inheritances for heirs
- Evaluate creditor rights in your state to see if they could claim insurance even with beneficiaries named
An estate planning lawyer can help craft a strategy around utilizing life insurance to handle debt repayment responsibly while still providing for heirs.
Using Trusts As Beneficiaries
Naming a trust as the beneficiary of a life insurance policy offers more control than naming individual beneficiaries. A trustee manages assets in the trust for beneficiaries based on the terms you set out.
Here are some benefits of using a trust:
- Avoids court oversight of insurance payouts
- Prevents beneficiaries from quickly spending lump sum
- Can provide lifetime income stream rather than lump payout
- Distributions can be staggered like 1/3 at age 25, half at 30, rest at 35
- Trust assets are protected from beneficiary’s creditors and spouses
- Trusts shield payouts for minors from court management until adulthood
Popular trusts used as beneficiaries include:
Revocable Living Trust
Easy to set up and offers control over distribution. Can be modified or revoked.
Irrevocable Life Insurance Trust (ILIT)
Protects insurance funds from estate taxes. Locks in terms for beneficiaries and can’t be changed.
Special Needs Trust
Allows inheritance for disabled beneficiaries without affecting government benefits.
An estate planning lawyer can help you determine if a trust aligns with your goals and how to set up the trust terms appropriately.
Unclaimed Life Insurance Funds
In rare cases, life insurance proceeds go unclaimed if beneficiaries cannot be located or are unaware they were named. Every state has an unclaimed property division that takes custody of these orphaned funds.
Tips on finding lost life insurance money:
- Contact deceased’s employer, union, credit union, or other groups where policy may have been obtained
- Search state unclaimed property databases which include life insurance proceeds
- Hire a company specializing in locating unclaimed life insurance funds for a fee
- Request records searches from insurers directly if you know which companies may have issued policies
It’s smart for every individual to maintain a detailed record of all life insurance policies and beneficiaries to avoid situations where funds go unclaimed. Let your heirs know where to locate your policy documents after you pass away.
Conclusion
Distributing life insurance proceeds without a will in place can be more complicated, costly, and time-consuming for beneficiaries. Intestacy laws often don’t align with an individual’s wishes. And having insurance paid into an estate can lead to unfavorable outcomes.
To make the process easier for loved ones, it’s critical to keep beneficiary designations up-to-date, consider naming a trust, and communicate your policy details to heirs. An estate planning attorney can help craft an optimal strategy for your situation.
With some planning, life insurance can remain a secure funding source to provide for your beneficiaries even without specific will instructions.
