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Keeping life insurance proceeds out of probate

We have been posting a number of blogs regarding probate issues over the past few weeks. Today, we'll discuss life insurance proceeds.

Why the general rule doesn't always apply

The rule is that life insurance proceeds skip probate so long as you have named beneficiaries who can take the payout. Upon your death, your beneficiaries receive their share directly from the insurance company.

However, this arrangement doesn't always go as planned. For example, the beneficiary you named in your policy may:

  • No longer be alive
  • Not be located
  • Disclaim (refuse to accept) the proceeds

Why disclaim? A person may disclaim an inheritance or life insurance proceeds for a number of reasons, such as keeping one's own estate below the taxable threshold.

If the life insurance proceeds are not deliverable to the intended beneficiaries, the proceeds will have to go through the probate process. The insurance company will issue a payout check to probate court, which will then determine who gets the money - to an heir named in the will or, where there is no will, to the heir designated under Colorado law. To avoid this, you may need to revised your list of named beneficiaries on occasion.

Beneficiaries and taxable estates

When you buy a life insurance policy, you sign a beneficiary designation form, just as you do with mutual fund investments and savings programs like IRAs and 401Ks. These signed documents actually override what you say in your will or in your trust documents.

There is another way to keep life insurance proceeds out of your taxable estate - by placing the proceeds in an irrevocable life insurance trust. Note that this is an ownership transfer. You cannot be the trustee of your own irrevocable trust, and the trust cannot be changed later on.

As always, your estate planning attorney can educate you about your options and guide you to the best solution for your situation.

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