Life Insurance and Wills: If You Have One, Do You Need the Other?

As a company that sells term life insurance, we get one question a lot: What’s the deal with life insurance and wills?

And that question is really a lot of questions bundled into one: How does life insurance work? What exactly is a last will and testament? If you have one, do you need the other? What if the choices in your will don’t align with what you chose for your life insurance policy? How does a trust fund come into the picture?

We’re here to break it down for you.

First, a few definitions. Life insurance is an agreement between you and an insurer saying that if you pass away during a certain time period, the insurer will pay a “death benefit” to the person you choose. For example, this could be your spouse or children.

Next, a will is a document that states your wishes upon your death, such as whom you’d like to care for your children, and who should inherit your assets. A trust, meanwhile, helps control not just who inherits your assets but how. So, for example, you could leave your estate to a trust that dictates that your child shouldn’t inherit until she turns 30 (whereas she’d otherwise inherit when she becomes a legal adult at 18). 

“The coronavirus has made it clear to many how necessary having life insurance and end-of-life instructions are to protect your loved ones,” says Michelle Stroble, a senior advisor with KPM Planning. “Do it now.”

If I Have Life Insurance, Do I Even Need a Will? 

A well-considered life insurance policy can cover a lot of expenses for your loved ones, but it shouldn’t be your only estate planning tool. Life insurance policies and wills operate in different ways. Namely, life insurance offers “new” funds to help your loved ones cover future expenses. A will, meanwhile, defines your wishes for the property you own now.

Life insurance benefits can do much more than cover funeral expenses. For example, your beneficiary can use the benefit to fund a college education or pay off a mortgage.

Unlike assets included in a will, an insurance policy payout does not have to go through the probate process. A will, meanwhile, specifies how your other assets are distributed—your home, your car, your personal belongings—and it must go through probate. That’s the process of taking your will before a judge who can ensure that it is sound and that its instructions are being carried out correctly. 

“If you don’t have a will,” Dan Papuga, a Certified Financial Planner with Northwestern Mutual, warns, “the state in which you live will appoint a lawyer who will be paid out of your assets, off the top, to settle your affairs in probate court. And they will dictate how long your assets will be frozen. In some places, it could take two to three years until all those affairs are settled, and only then would remaining assets be paid to the named beneficiaries.”

What If My Life Insurance Policy Contradicts My Will?

A common misconception is that the will takes precedence over other instructions, but that’s not always the case. For example, maybe you name one person as a beneficiary on your policy, but name someone else as your beneficiary in your will. What happens then?

In short, a life insurance policy isn’t contingent on your will, so the person you named in your policy will get the life insurance benefit. The person you named in your will, however, is eligible to receive everything else covered by the will, like property and possessions.

New instructions in your will won’t override the beneficiary designation you made on your life insurance policy. If you want to change the beneficiary of your life insurance policy and the beneficiary of your will, you’ll need to update that information in both places.

Can I Direct My Insurance to ‘Follow the Directions in My Will’?

Often, the answer is no. For many policies, such as the one sold by Fabric, you can’t redirect your life insurance benefit to the instructions in an existing will. If you want your life insurance choices to be consistent with the choices you’ve made in your will, you’ll usually need to simply make sure you coordinate those decisions in both places. 

Another option is to designate a trust as the beneficiary of both your will and your life insurance policy. That would grant you finer-tuned control over how your assets are distributed, and would ensure that your choices are consistent across the board (because they all redirect to the same trust). 

Your life insurance beneficiary takes precedence (for the death benefit from your insurer) over the person you’ve named in your will. The only exception is if your designated beneficiary dies before you do. In that case, if you don’t have a named beneficiary for your life insurance policy, the death benefit would go to your estate and pass through the probate process.

That is why it is wise to have a contingent beneficiary—that’s essentially a backup beneficiary—and to review all of these documents on a regular basis, as well as every time you have a major life change. 

Find out how to choose a beneficiary for your life insurance policy and your will.

Can I Make a Trust My Beneficiary?      

You can name a trust as a beneficiary of a life insurance policy. 

There are two types of trusts that are specialized for life insurance: an irrevocable life insurance trust (ILIT) and a revocable life insurance trust (RLIT). These trusts are constructed so that life insurance policy is the primary asset owned by the trust. (You can also name a “regular” trust as a beneficiary of a life insurance policy.)

An RLIT is a life insurance trust to which you can make changes down the line, while an ILIT cannot be changed later. 

Why would you want a trust that reduces your flexibility and forbids you from making any changes down the line? The main reason people tend to use ILITs is to reap the benefits of the fact that they aren’t taxable. So, you might use an ILIT to set aside money for a predetermined purpose, such as paying off estate taxes. That said, the lack of flexibility is a major drawback of ILITs. Plus, while ILIT assets get excluded from your estate for tax purposes, they are included as part of your beneficiaries’ estate. Bottom line? ILITs tend to make the most sense for people with very considerable assets, since estate tax doesn’t kick in until you’ve got more than $11 million to pass on.

RLITs, meanwhile, offer limited benefits since they function largely the same way as a designated beneficiary in a life insurance policy. The main pro of this approach is that if you were incapacitated, your trustee could more easily take the helm.

These types of trusts are typically a more expensive route because not only do you have to pay insurance premiums, you also have to pay trust administration fees. 

What If I Live in a Community Property State?

Community property laws mean that unless there’s a prenuptial agreement, each partner in a marriage is entitled to half of the assets accumulated during the marriage. The proceeds from a life insurance policy are assets, so you might think that the surviving spouse would get half of those proceeds in a community property state. 

But that’s not the case. Life insurance policies are separate because insurance is a contract that’s independent of community property law. For example, the beneficiary of your life insurance policy can even be someone other than your spouse. 

That said, whole life insurance policies have a “cash value” component, which means that the money you put into the policy doesn’t just disappear. You have the ability to withdraw some or all of the money while you are still alive, if you choose (although this can have a negative effect on the death benefit if you were to pass away). 

As a result of this cash value feature of whole life, half of the premiums that are paid for the insurance during the marriage are community property. That’s because at the time, the money for the premiums belonged to both parties. Still, if the surviving spouse wanted access to those funds, they would likely have to seek legal action to recoup them from the policy’s beneficiaries. 

There are currently nine states with community property laws: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin. Three additional states Alaska, South Dakota and Tennessee—allow spouses to opt in to community property. The territories Puerto Rico and Guam also have community property laws. 

Taking the Plunge

At the end of the day, one of the most impactful things you can do for your family is to start getting these basic pillars of estate planning in place: a will, a life insurance policy and, if it makes sense for your needs, a trust. (For example, here's a peek at the choices one real mom made in her will.)

Stroble points out that many people may qualify for term insurance policies with monthly payments less than a cable or phone bill. For example, a 30-year-old woman in Florida in excellent health might be able to get $500,000 in 20-year term life insurance for about $25 a month, based on a life insurance quote from Fabric.

“Unfortunately, many people, particularly people of color, view insurance as an expense and not as a priority,” Stroble says. “For African Americans and other people of color in particular, the pattern has been like Sisyphus where one generation pushes the rock up the hill only for it to slide back down because of the lack of insurance, a will and a trust.”

It’s tempting to avoid discussions about life insurance, wills and trusts. However, there are numerous financial advisors who can help you develop an overall plan as well as review the legal and tax implications of your choices. Talking about death is awkward, but the consequences of not having these conversations are significant for your loved ones. If you need additional motivation to document your wishes, do it for them.

Fabric exists to help young families master their money. Our articles abide by strict editorial standards.

Information provided is general and educational in nature, is not financial advice, and all products or services discussed may not be offered by Fabric by Gerber Life  (“the Company”). The information is not intended to be, and should not be construed as, legal or tax advice. The Company does not provide legal or tax advice. Consult an attorney or tax advisor regarding your specific legal or tax situation. Laws of a specific state or laws relevant to a particular situation may affect the applicability, accuracy, or completeness of this information. Federal and state laws and regulations are complex and are subject to change. The Company makes no warranties with regard to the information or results obtained by its use. The Company disclaims any liability arising out of your use of, or reliance on, the information. The views and opinions of third-party content providers are solely those of the author and not Fabric by Gerber Life.