Many people use life insurance policies as a big part of the assets they plan to pass on to their children. Even if they do not have significant assets saved up, they know that a large policy is guaranteed to give their children a financial boost when they pass away. They may spend years or even decades paying into it.
One important thing to remember is that, while the policy can look like part of your estate, it does not always get divided like the rest of your estate. Specifically, the beneficiary that you pick when you buy the policy is going to take precedence over whatever you write in the will.
Let’s look at this from a child’s perspective. Imagine that your parents talked to you and your older sibling about the estate plan. They told you that they planned to divide everything evenly. They showed you the will, which stated that all of the assets in their estate should get split 50/50 between the two of you.
You know that was their goal. When they pass away, though, you find out that only your older sibling got listed as the beneficiary. You hadn’t even been born when your parents took out the long-term life insurance policy. They just listed your sibling and forgot to update it.
Does the policy get split 50/50, like you know they wanted? No. It just pays out in full to your sibling. They get 100%. They can give you half of it if they want — they know what your parents’ goal was — but they don’t have to. The law doesn’t give them any obligation. They could also keep the entire payout. As the beneficiary, they’re the only one with a legal claim.
Why doesn’t the will matter? It does. It just doesn’t touch the life insurance policy. Before your parents pass away, that money belongs to the insurance company. As soon as they pass away, it pays out to your sibling. It never enters your parents’ estate at all. The will just divides the assets they controlled before their death.
As you can see, estate planning mistakes and misconceptions can cause a lot of confusion. It is very important not only for those who create these plans to know what steps to take, but for those named in the plans to understand what they’re entitled to, how the law works and what legal rights they have.