Is Life Insurance Part of an Estate?

Whether the proceeds of a life insurance policy will be part of an estate depends on who owns the policy. If you own a life insurance policy on yourself, the death benefit will be part of your estate. If someone else owns the policy, the benefit will not be included in your estate. The distinction matters because the estate assets can be used to pay the outstanding debts of the deceased, and larger estates are subject to estate tax.


Insured, Owner and Beneficiary

Life insurance policies have "insured persons," "owners" and "beneficiaries." The insured is the individual covered by the policy. When the insured dies, the policy pays a death benefit. A beneficiary is designated to receive some or all of the death benefit. The owner of a policy, meanwhile, has the power to make decisions about it. The owner can name or change the beneficiaries, dictate how the death benefit will be paid out, and even borrow money against the policy. The owner can also transfer ownership or cancel the policy entirely. Usually, but not always, the owner pays the premiums. Sometimes, the owner and the beneficiary are the same person. With life insurance, it's common for the insured person to be the owner.


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Ownership Determines Tax Status

If you are the owner of your life insurance policy, the death benefit will be considered part of your estate when you die regardless of who is named as the beneficiary. That means your creditors can try to claim the money to pay any debts you leave behind. In the case of a claim large enough to trigger the estate tax, the estate will have to pay taxes on the benefit before it can be paid to the beneficiary or beneficiaries. If the owner is someone besides the insured, though, the policy can pay the beneficiaries directly. The payments are not taxed, and creditors can't lay claim to the money.


Extent of the Effects

Very few families actually have to pay estate tax. As of 2015, only estates with assets of more than $5.43 million were subject to the tax. According to estimates from the Tax Policy Center, less than 1 percent of estates were large enough to tax. Still, it is possible for a large death benefit to push an otherwise untaxed estate over the threshold.

Tax Planning Options

Every person's finances are different, and a qualified financial planner may be best positioned to advise you on your specific situation. That said, there are some common strategies people use to keep death benefits out of an estate. First of all, estates can pass between spouses with no taxes whatsoever. If you own your policy and your spouse is the sole beneficiary, there will be no tax problem. If your beneficiaries include anyone else, including children, you could transfer ownership of the policy to a beneficiary or a third party. Or you could set up a life insurance trust, which would act as the owner of the policy, and then you could assign ownership interest in the trust to your beneficiaries.