What Happens If the Owner of a Life Insurance Policy Dies Before the Insured?

Purchasing life insurance is an important part of financial planning. But what happens if the policy owner passes away before the insured person? This situation can create complications if the policy ownership has not been properly arranged.

This article provides a comprehensive overview of how life insurance policies are impacted when an owner dies first, how to avoid potential problems, and how to ensure your policy proceeds go where you intend.

Life Insurance Policy Ownership

First, it’s helpful to understand some basics about life insurance ownership:

• The owner is the person who applies for, purchases, and has control over the policy.

• The insured is the person whose death triggers the payout of policy proceeds.

• The beneficiary receives the death benefit when the insured dies.

The owner and insured can be the same person, but are often different. For example, a wife may own a policy insuring her husband’s life, with their children as beneficiaries.

The owner has control over the policy, including the right to name beneficiaries, borrow against the policy, make premium payments, and more.

What Happens When the Owner Passes Away

If the policy owner dies before the insured person, here’s what happens:

• The policy becomes part of the owner’s estate and is subject to probate.

• Ownership transfers to heirs either per the owner’s will or by state intestacy laws if no will exists.

• The new owner(s) gain control over the policy.

• Beneficiaries can potentially be changed by the new owner(s).

Unless provisions have been made, the policy essentially becomes frozen until the probate process completes. The end result may be very different than the original owner’s intentions.

Problems That Can Arise

There are a few potential issues that can come up if an owner passes away before properly arranging successor ownership:

• Delays – The probate process can tie up the policy for weeks or months.

• Unintended new owners – Ownership may transfer to heirs not originally intended to control the policy.

• Loss of control – If ownership is divided among multiple heirs, policy control becomes fragmented.

• Creditors – Life insurance proceeds may become accessible to the deceased owner’s creditors.

• Taxes – Depending on the specifics, death benefits could become taxable in the original owner’s estate.

• Beneficiary changes – New owners may alter beneficiary designations against the original owner’s wishes.

The end result is often costly legal complications and uncertainty over the policy’s management and benefits.

Avoiding Problems With Successor Owners

The solution is quite simple – designate a successor owner on the life insurance policy. Here are two main options:

• Name at least one successor owner – This person assumes full control in the event of the original owner’s death.

• Have an entity such as a trust own the policy – Avoids individual successor owner issues.

With proper successor owners named, the policy passes outside of probate and avoids the potential pitfalls outlined above.

Successor owners should be designated when the policy is purchased. But existing policies can be updated by contacting your life insurance company.

Special Considerations for Different Scenarios

While successor owners solve many issues, some special situations require additional planning:

• Community property states – Spouses may need to take special steps to avoid unintended estate implications.

• Married couples – Ensure ownership and beneficiaries align with intentions for the surviving spouse.

• Children – Guardians or trusts may need to be designated if minors are beneficiaries.

• Estate taxes – Special trusts or policy structures may be warranted if estate taxes are a concern.

• Businesses – Take care to avoid unwanted tax consequences when a business owns policies on employees.

Discussing your unique situation with a financial advisor or estate planning attorney can identify any special issues to address.

Options for Existing Policies Without Successor Owners

For existing policies without named successor owners, there are a few options if the owner passes away:

• Structuring a sale – The deceased owner’s heirs can sell the policy to intended recipients.

• Using a life settlement – Sell the policy to a third party investor through a life settlement.

• Naming new owners – Update ownership to align with current wishes.

• Letting policy lapse – The new owner declines to continue premium payments.

Each approach has pros and cons to weigh carefully before making a decision. Consulting a tax advisor is crucial to avoid unintended tax implications.

Conclusion

The original owner’s vision for a life insurance policy can be disrupted if they die before the insured and have not designated a successor owner. Costly legal and tax consequences, delays, and confusion over the policy’s management can result. Designating successor owners or having a trust own the policy helps ensure your specific intentions for the death benefit are met. Discussing your situation with a financial professional can provide guidance on structuring your policy ownership and beneficiaries to avoid any disruptions.

Common Questions About Life Insurance Owners Passing Away

Here are some frequently asked questions about what happens when a life insurance owner dies first:

What is the impact if a married couple jointly owns a policy?

The surviving spouse will retain full ownership rights over the policy without the need for probate. Joint ownership ensures there is a seamless transition.

Can I name a minor child as the successor owner?

You can, but the court will have to appoint a guardian to handle the policy on the child’s behalf until they become an adult.

What if the new owner decides to take out a loan against the policy?

As full owner, they would have the right to borrow against the policy value regardless of the original owner’s intentions.

Is it better to have a trust own the policy instead of naming individual successor owners?

Often yes, because it avoids any uncertainty over who becomes the new owner after the original owner’s death.

What happens if all named successors die before the original owner?

Then the policy would revert back to the owner’s estate and pass according to their will or state laws if no will exists.

Can I name multiple successor owners for a single policy?

Yes, you can name multiple individuals as joint successor owners. But joint ownership can create complications.

Do I need to update successor owners if I live in a community property state?

Yes, your spouse may automatically have a half-interest in the policy, so additional steps may be needed.

Do successor owners need to continue paying premiums?

Yes, the successor owner must keep premiums paid just like the original owner in order for the policy to remain in force.

Can successor owners be changed later if circumstances change?

Absolutely. As policy owner, you can change successor owner designations anytime by contacting your insurer.