Will It (My Home, My Life Insurance, Etc.) Be in My Estate?

This is an important question to ask, because the answer could tell you whether you need to worry about estate taxes, beneficiary issues or probate concerns.

A Post-It Note with a question mark.
(Image credit: Getty Images)

As an estate planner for over 40 years, I’m frequently asked whether a particular asset will “be in my estate?” It could be any kind of asset: life insurance, real estate, an employment contract. Rather than give my standard lawyer’s answer of “it depends,” the better answer is “define what you mean by ‘estate.’”

When you die, your estate can have different meanings for different planning purposes. It can be your gross estate for the federal estate tax, your probate estate, or you may be thinking in terms of whether the asset will be available as part of your estate to pass on to your heirs. Which aspect of your estate you’re focused on will affect the answer to the question.

The Value of Your Estate for Federal Estate Taxes vs. Probate

Consider life insurance. You buy a $500,000 policy on your life, naming your daughter the beneficiary. Assuming you own the policy, when you die the entire $500,000 death benefit will be included in your gross estate for purposes of the federal estate tax. If your estate is big enough (over $11.7 million in 2021 and rising to $12.06 million in 2022), the entire death benefit over that exemption is subject to a 40% federal estate tax.

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If, however, by “estate” you’re asking if the policy will be included in your probate estate, the answer is no — none of the proceeds from your life insurance are subject to probate. This is because the death benefit passes by contract and is not considered a probate asset.

Finally, if you’re asking whether the policy is an estate asset in the sense that it will be available for heirs, creditors taxing authorities and the like, the answer is a little more nuanced. Since you’ve named your daughter the beneficiary of your life insurance policy, the estate can’t use the proceeds for fulfilling bequests you’ve made to others. Even if you’ve disowned your daughter and changed your will to pass your wealth to your other children, the life insurance policy is a contract. Unless you name a new beneficiary, the money will still go to your disowned daughter.

Now, whether any of those proceeds can be diverted to pay creditors, taxes and other estate obligations depends on how your last will and testament allocates the payment of estate expenses. Your daughter still receives $500,000 from the insurance company, but in your will you can direct that her share of the probate estate be reduced to reflect her share of costs associated with probate. This assumes your probate estate has enough money to pay these obligations. Otherwise, some of the $500,000 insurance proceeds may conceivably be tapped to pay taxes. The IRS has numerous means to collect its share of estate costs — even from beneficiaries.

Where You Live Matters

In figuring out what you mean by “in my estate,” you not only need to define the term, but also identify where you call home — or, legally speaking, where you are domiciled. For example, there are nine community property states (Arizona, California, Idaho, Louisiana, New Mexico, Nevada, Texas, Washington and Wisconsin). Assets in these states are treated differently for estate tax purposes than property owned by married couples who live in common law jurisdictions. Similarly, in most states, real estate held on a fee simple basis is transferred at death through the probate estate. However, in some states an alternative exists to use a transfer-on-death (TOD) deed. This is akin to a TOD bank account where you can leave your account directly to another upon your death.

All of this “legal speak” makes a difference, because if property is in your probate estate you may be looking at expenses typically anywhere from 2% to 6%, whereas when the asset is out of the probate estate, no probate costs attach.

The Bottom Line

The moral of this story is to know what you’re asking in order to get a more useful answer:

  • If you’re worried about estate taxes, the question to ask is whether the asset is in your gross estate. Presumably you are asking because you’re wondering if there is a way to avoid having that asset be part of your gross estate, such as using present interest annual exclusion gifts.
  • If, instead, your concern is about the costs of probate, the question to ask is how can you remove assets from probate — for example by transferring property to a living trust.
  • And finally, if by “Will it be in my estate?” you’re asking whether an asset will be available to pass on to an heir, work with your attorney to create a last will and testament. That way you can control how probate assets will be distributed.

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

Steve Parrish, J.D., RICP®
Co-Director, Retirement Income Center, The American College of Financial Services

Steve Parrish, JD, RICP®, CLU®, ChFC®, RHU®, AEP®, is an Adjunct Professor of Advanced Planning and Co-Director of the Retirement Income Center at The American College of Financial Services. His career includes years spent as a financial adviser, attorney and financial service company executive. He focuses on law, estate planning, taxes and financial strategies that can help enable a successful retirement.