If you have a life insurance policy, do you know who your beneficiary is?
As is so often the case, the simple planning steps often get overlooked. Ironically, although folks tend to spend a lot of time evaluating life insurance policies to ensure they cover their loved ones, the beneficiary designation gets far less consideration and is rarely reviewed.
A critical mistake many make is naming “my estate” as the beneficiary. Doing so exposes your life insurance proceeds to state estate taxes and federal estate taxes if your estate surpasses the current $5.25 million exemption.
A more tax-aware decision is to list your spouse as the beneficiary. However, you should also name one or more secondary beneficiaries. That way, if you and your spouse die at the same time, you avoid having your life insurance proceeds go right back into your estate.
You also could name your children as your primary beneficiary, but that could leave your spouse without the assets that he or she may need to meet expenses. And there’s another problem with naming one child as the beneficiary and asking her to divide the money with her siblings. Here’s the deal: Life insurance proceeds would be distributed to your daughter–the beneficiary–tax-free. However, when she pays her siblings their share, those payments become taxable gifts, from her to them.
You can see why many folks create an irrevocable life insurance trust as their beneficiary. This ensures that your life insurance won’t be included in your taxable estate. And if the trust is drawn up properly, it could mean that your life insurance benefit will be available to your spouse and then to your kids, and even to your grandkids and their kids, free of estate taxes.
And speaking of beneficiaries, don’t forget to review and update the beneficiaries on your retirement accounts. Consult your financial advisor if you have any questions.