Will your life insurance policy have to be used to pay off your final bills and debts? The answer to that question depends, in large part, on the beneficiary designation of your policy.
Policy Payable to Estate
There are two ways for your life insurance policy to be paid to your estate. First, you might actually designate your estate as beneficiary of your policy. Second, you might designate a person as beneficiary who dies before you. If this happens, and you don’t appoint a new beneficiary before you pass away, then depending on your insurance company’s rules, the policy proceeds may be paid to your estate.
When the proceeds of your life insurance are paid to your estate, they’re considered probate property. And, before probate property can be distributed to the heirs or beneficiaries of your estate, your legitimate final bills and debts have to be paid. How is this done? Using probate property. So, in this scenario, your life insurance proceeds (or a portion of them) could be used to pay your final bills and debts.
Policy Payable to Beneficiary
What if you designate a beneficiary, other than your estate, who outlives you and receives your life insurance proceeds? In this situation, your life insurance proceeds are non-probate property. They never go through the probate process, so there’s no requirement that they be used to pay off your final bills and debts.
What About Estate Taxes?
Estate taxes, on the other hand, are a different story. A life insurance policy owned by you at the time of your death – while it might not be probate property – is included in your gross estate for purposes of calculating estate tax. So, there’s a chance that part of the proceeds from your life insurance policy could be needed to pay off any estate tax bill.