Generally, you designate a beneficiary for your life insurance when you purchase the policy. If you were undecided at that time, then you – or rather your estate – will be the beneficiary. Be sure to update your policy and decide on the best beneficiary or you’ll undermine a lot of the benefits that life insurance payout can give your eventual beneficiary.

When you update your beneficiary, you can name more than one and give each a specified percentage of the benefit. For instance you could leave 30% to each of 3 children and 5% to each of 2 grandchildren.

Using the estate as an intermediate beneficiary undermines a lot of the benefits that life insurance proceeds afford to ‘named’ beneficiaries. Proceeds are first distributed according to how the rest of the estate is divided according to your will; or, if you don’t have a will – according to your state’s distribution laws for intestate. 

Benefits to named beneficiaries versus leaving the policy to your estate:

Several immediate benefits for named beneficiaries versus your estate beneficiary are:

• Speed: In most cases life insurance companies pay the life insurance to the beneficiaries as soon as a claim is filed. If the estate receives the proceeds, the probate process can take quite a while, and the estate money is also subject to disputes among the beneficiaries of the will.

• Taxes: Life insurance benefits at distribution are free of income tax obligations for individual beneficiaries. Life insurance owned by you will still have the value of its proceeds included in your estate – and therefore subject to estate tax. But left to the estate, the proceeds will be subject not only to estate taxes directly, but also estate income tax during the probate process.

• Debts: If you die with outstanding debts owed, your life insurance beneficiaries receive the insurance proceeds free of debt obligations and your creditors don’t have access to the proceeds. But if the proceeds go to the estate creditors and bill collectors are obliged to be paid out of your estate before any payments go to the beneficiaries of your will.

Remember to seek advice of a trusted tax professional on issues involving income taxes and an estate attorney on issues involving wills.

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