How Does Life Insurance End up in Probate?

Life Insurance by definition is supposed to payout, at your death, to the “Primary Beneficiary”, simply by showing a Death Certificate and without the need for Probate. Four critical questions: 1) Why do some Life Insurance Polices end up in Probate? 2) Who will ultimately end up with the proceeds of the Life Insurance Policy? 3) Will the proceeds be subject to Creditor Claims? and, 4) How long will it take to collect the proceeds? Fortunately, I have 37 years of Estate Planning experience as an Attorney practicing in Probate as well as 7 years of experience before that as a Life Insurance agent with Northwestern Mutual Life.

Over the years it seems as though there are three or four cases per year where a Life Insurance policy ends up in the Probate Court. Why? There are four common reasons why the policy ends up in Probate.

1. The most common is that the Owner of the policy designated “My Estate” as the beneficiary of the Life Insurance policy. This is generally a big mistake by the Owner, maybe acting on bad advice, or more likely doing it without seeking proper advice. By definition, “My Estate” means probate. It means giving the proceeds of the policy to whomever is named as a beneficiary under the Will. And, the Will by definition must go through probate to have any validity. Generally, the best result on Life Insurance is to designate “people” as the beneficiaries, not “My Estate”.

1. Another common reason a Life Insurance Policy ends up in Probate is that the designated beneficiary died before the Insured died and the Insured never changed the beneficiary form. Generally, this is easily avoided one of two ways; First, make sure that you designate a “contingent beneficiary” to receive the proceeds in the event the “primary beneficiary” predeceases, and/or second, make sure you review all of your Life Insurance beneficiary designations frequently. Certainly, when you prepare your Will or your Trust, make sure you review your beneficiary designations and coordinate them with the beneficiaries of your Will and your Trust.

1. Another possibility is some sort of failure in properly designating a beneficiary of the policy. I have seen cases where the Life Insurance Company takes the position that they never received a proper designation. This is why you should have the Company send you a written confirmation acknowledging that they received your change of beneficiary form when you made a change. I have also seen cases where the beneficiary form was incomplete, or not signed or some other failure.

1. And the last possibility is that someone that wasn’t named as the beneficiary of the policy is challenging the beneficiary that was designated. This may happen when the Owner designates his or her spouse as the beneficiary while they were married but fails to change it after a divorce. As such, the children of the decedent/owner want to challenge the ex-spouse as the beneficiary. Or you could have a situation where the policy premiums were paid for out of community property funds during the marriage and the ex-spouse raises a community property claim that he or she should be the rightful beneficiary even though the policy was changed to the children prior to the Owner’s death. There could be other legal challenges to the beneficiary that was designated under some sort of Business Arrangement or Buy/Sell Agreement.

Who ultimately ends up with the proceeds of the policy? That is very complicated and depends on which one of the 4 reasons above that the policy actually ended up in Probate Court. If “My Estate” was designated as the beneficiary, then it will go to the named beneficiaries under the Will in Probate Court. If there is no proper beneficiary named, then there may be a “default provision” in the Policy that will dictate who it is paid to such as the surviving spouse, or children, etc. If the policy doesn’t have a “default clause”, then it is back to the “Estate” and will end up going to the named beneficiaries under the Will. If the designation of beneficiary under the policy is challenged by another person, then that challenge is appropriate in Probate Court and who it goes to will depend on the outcome of the litigation.

In the end, Life Insurance proceeds should never end up in Probate Court. And, if it does, it is generally because someone has made a mistake. Now, the next question is whether or not the proceeds, if payable to the Estate, are the proceeds subject to the general creditors of the Estate? The “general creditors of the Estate” could be the IRS, medical bills, legal fees, credit card or consumer debt, etc. But, there is an Arizona Statute that provides that the general rule is that the proceeds of a Life Insurance payable to an Estate are not subject to the general creditors of the Estate.

The last question is the most difficult question of all to answer. How long will it take to get my Life Insurance proceeds designated and payable to an Estate? The general answer is that it will take 1 to 2 years in most States if there is no litigation and 2 to 3 years if there is litigation. Certainly, you should hire competent legal counsel to represent your legal interests in any probate where there are Life Insurance proceeds that you thought should have been paid directly to you. Remember, you are in this situation because somebody made a mistake. Don’t you make another mistake.

Many law firms, like ours, will take the case on an “hourly rate basis”, meaning you pay us for our time as we represent your legal interests in the policy and in the Estate. And, sometimes, if your case is strong, we may be willing to take such a case on a “contingency fee basis”. This means that if we don’t win, then you pay us nothing. But, if we do win, you pay us a percentage of what we collect. A typical contingency fee in this situation is about 1/3 of the policy proceeds. This is similar to the contingency fee arrangements you typically see in Personal Injury/car accident types of cases.

In an hourly rate case, what if you don’t have the cash for a retainer? The good news is that if your case is strong, there are finance companies out there that will “loan you the money” so you can hire a lawyer, and maybe even give you a few extra bucks upfront. And, in some cases, these companies may actually buy your equitable position in the Probate, and you get your money now and they step in and fight the case for you. The bottom line is that you should quickly seek good competent advice. There are time constraints in bringing your claim. Waiting too long could result in the loss of legal rights.