Life Insurance Policy Ownership Pitfalls: What Should I be Aware of?Life insurance can play an important role in an estate plan. Insurance may provide income replacement to a surviving spouse or liquidity to an estate where the majority of the estate’s value is tied up in a family business or real property. Insurance can provide the funds that an estate needs for taxes or just more inheritance dollars for loved ones.
During the last few years however we have seen a number of insurance cases that became problematic because of a failure to properly correlate the owner, insured and beneficiary of an insurance policy.
There are basic insurance terms that everyone should know and periodically review to make sure that an insurance policy works properly.
- Owner: The owner of a life insurance policy is the person who has rights over the policy, can change the policy’s beneficiary and/or cash it out, etc. Normally the policy owner is also the insured.
- Insured: : The insured under a life insurance policy is the person covered or protected, the person who if he or she dies, the insurance company will have the obligation to pay out the death benefits to the beneficiary.
- Beneficiary: The beneficiary is the one entitled to receive the death benefits under the policy when the insured person dies.
The problem we have recently seen is when the owner of an insurance policy is someone other than the insured and then the owner dies first.
What happens in this scenario is that, because the owner died first, but the insured is still alive, there is no money (death benefit) paid out, yet the premiums to keep the policy active must continue being paid for the duration of the insured person’s life.
The ownership of such policies will also need to be changed from the deceased person’s name to his or her estate beneficiaries listed under the terms of a Will or by intestate distribution (without a Will). Then the new owners (those entitled to the deceased owner’s estate) collectively must pay the premiums on the policy for the duration of the insured’s life to eventually collect the death benefits under the policy.
Hopefully you can see the many problems with this scenario: probate for a policy that will not pay out any death benefit; continued payment of premiums by multiple persons, who may or may not contribute; change of ownership, etc. What usually happens is that the policy will lapse for non-payment of premiums and no one ever receives the intended death benefits.
How can this be avoided? You should look carefully at who are the owner, insured and beneficiary of each life insurance policy and make sure that if the owner and insured are two different individuals, there is a plan for the smooth continuation of the policy if the owner happens to die first. One easy solution to this problem would be to transfer the ownership of the policy to a revocable or irrevocable trust.
If you have any questions regarding family based estate planning or any other legal issues, please call the estate planning attorneys at Rowley Chapman & Barney, Ltd. at (480) 833-1113.