Life insurance policies and annuities provide an important, but often untapped, benefit when it comes to privacy and the disposition of assets.
Privacy is an important issue for many people, especially as it pertains to their financial matters. During their lifetime, people often go to great lengths to maintain the confidentiality of their financial matters. Unfortunately, when it comes to the final disposition of one's assets, such privacy can often be difficult to retain. The vast majority of people create a will to pass on their assets. To take effect, however, wills must pass through probate court, which means the contents and disposition of much of the estate becomes a matter of public record, if not public knowledge.
While privacy is often a concern for public figures, or wealthy individuals, even people of more modest means may have their reasons for wanting to keep some final financial arrangements private.
Life insurance policies and annuities provide an important, but often untapped, benefit when it comes to privacy and the disposition of assets. Probated wills are public documents, but life insurance and annuity polices are private contracts. They do not have to be mentioned in a will and do not normally pass through probate. As a result, life insurance and annuity policies can be used to pass along assets with the utmost confidentiality and privacy intact.
Importance of a Will
This is not to suggest life insurance and annuities can be used as a substitute for a will, merely that in some cases they can be used outside of a will to avoid probate and maintain confidentiality. Whether an estate is large or small, you should plan to transfer what you own with a properly executed will and then, depending on your wishes, begin to examine alternatives. Wills are important legal documents because they allow you to decide who you would like to receive your property and other assets. If you die without a will, or intestate, the courts in the state where you live make those decisions for you. (In most cases the surviving spouse and immediate family members are the primary recipients.)
While probate is a formality in the majority of cases, some people may not want to go through it and desire, as much as possible, the contents of their estate and finances to remain private. For those people life insurance and annuity contracts may be helpful.
Understanding Probate
Before learning how life insurance and annuities can be used to maintain privacy and avoid probate, it may be helpful to understand the probate process.
Probate is a legal process that takes place after someone dies. According to "Probate FAQ," a 2002 article on public.findlaw.com, it includes:
- Proving in court that a deceased person's will is valid (usually a routine matter)
- Identifying and inventorying the deceased person's property
- Having the property appraised
- Paying debts and taxes
- Distributing the remaining property as the will directs
Typically, probate involves only paperwork and court appearances by lawyers. The entire process becomes a matter of public record.
Most states allow a certain amount of property to pass free of probate through a simplified procedure. In California for example, according to a 2002 article entitled "Probate FAQ" available on publicfindlaw.com, you can pass up to $100,000 of property without probate and a simple procedure transfers any property left to a surviving spouse.
Four Tools to Avoid Probate
If you wish to avoid probate as much as possible for privacy reasons, according to a December 1994 article "Avoiding Probate" that is currently available on CPA Journal Online (www.luca.com, Note: this is the most recent source) there are four basic estate planning tools to help: joint tenancy, beneficiary designations, gifting, and living trusts.
This article focuses on beneficiary designations, and briefly touches on the others. Be sure to consult with your attorney, trust officer or financial advisor before taking any steps in any of these areas.
Beneficiary Designations
Beneficiary designations under life insurance and annuity policies, including retirement plans (e.g. pension, profit sharing and 401(k) s and IRAs) avoid probate, according to the CPA Journal Online article mentioned above, because they constitute contractual or trust obligations, which specify the person(s) to whom the proceeds should be paid. For example, under a life insurance policy, a policyowner contracts with the life insurance company to pay out a death benefit to a designated beneficiary or beneficiaries. There is no need for probate, a court decree indicating who should receive the insurance proceeds because that has already been provided by the contract.
Who can benefit from a life insurance policy?
To pass along the proceeds of a life insurance policy the key is to name a beneficiary. In most instances it is a family member, but it can be a friend or, for charitable donation purposes, an institution. One possible use could be for to fund an education, to make sure a child's college can be paid for free and clear of any estate taxes or potential problems. Other possible uses include to pay off a mortgage, or to help pay expenses for a friend or relative who cannot care for themselves.
Annuities
Using an annuity to fund a Roth IRA is a good way to pass along a large amount of money and retain privacy. While the Roth IRA has some eligibility standards, it allows people to pass on a large amount of money at death and avoid probate, according to a 2002 article on public.findlaw.com, "Using Roth IRA's to Avoid Probate." With a traditional IRA you must start making withdrawals after you reach age 70½. The amount you must withdraw each year depends on you age and the age of your beneficiary. The idea is that you will use up your retirement income by the time you die.
But a Roth IRA has no mandatory withdrawals. That means you can let the account keep accumulating, income tax-free, until your death, when it will pass to the person you've named. The only constraints on the amount of money you can save are the contribution limits, currently $3,000 a year ($6,000 for couples filing a joint return) and the results of your investment choices. Because it is a private contract, you don't need to mention the IRA in your will. After your death, the beneficiary will need only a certified copy of the death certificate to claim the funds quickly and without probate.
In some states, stocks and other securities can also be passed through free of probate by naming a beneficiary. Real estate and other types of property normally cannot use beneficiary designations to avoid probate.
Gifts
Anything you give away during your lifetime doesn't have to go through probate. Making non taxable gifts (up to $11,000 per recipient per year can also reduce eventual federal estate taxes.
Joint Tenancy: According to the State Bar of South Dakota, Joint tenancy is "a type of ownership in which two or more people share an interest in personal property or real estate. If the interest is as tenants in common, each person owns an undivided but individual interest which goes to his heirs at death. If the interest is "with right of survivorship", the interest goes to the surviving joint owner."
The other type of joint tenancy is "joint tenancy with rights of survivorship." This can apply to all types of assets including stocks, bonds, real estate and automobiles for example. All the surviving joint tenant needs to do to establish ownership is to show a death certificate of the deceased joint tenant. The succession is automatic and probate court is unnecessary. Using joint tenancy can be tricky, however, with respect to gift taxes. Always consult your attorney or financial advisor before initiating any steps.
Living Trusts
The fourth way to avoid probate and maintain your privacy and confidentiality of your estate is through a living trust, so called because it is established during the lifetime of the person who creates the trust. There are two types of trusts: a revocable living trust gives the creator the right to dissolve the trust at any time and an irrevocable living trust cannot be dissolved by the creator. Anyone can establish a trust even if your estate is small. There are, however, costs involved. You will pay fees to establish and manage a trust. Make sure your estate is large enough to justify those fees. For a complete discussion of trusts consult an estate planning attorney, a bank trust officer or your financial advisor.
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