I just purchased my first life insurance policy. Do I need to update my will?

When you buy life insurance, you must name the beneficiaries of the policy. If you prefer, the proceeds of the policy could be left to your estate and then divided up according to the dictates of your will. There are advantages to naming your estate as the beneficiary, but there are also costly drawbacks. In most circumstances, it would be better to name the beneficiaries of the life insurance policy directly, keeping it distinct from the estate.

One reason that the beneficiary of the will might be your estate is a situation where you are unsure of the number of heirs the proceeds will be divided between. For example, if your son has just gotten married and was trying for a first child, you might want the inheritance to be able to be divided up between an unknown number of grandkids at some future date. Naming your estate is useful for liquidating assets after your death as well.

The major drawback for naming your estate as the beneficiary of a life insurance policy is that once the money goes to your estate it becomes immediately taxable. By leaving the proceeds to specific beneficiaries, taxes on the settlement can be avoided, but if the settlement pays out to your estate, the money must be treated the same as all other assets and taxed accordingly. If you want to avoid the settlement being taxed, set up a trust fund that can administer the settlement for you.

On the other hand, there is nothing wrong with updating your will to verify the life insurance beneficiaries. The problem which could arise here would be if you changed the will or the policy but did not change the other. For instance, if you added your grandson to the will but forgot to update the life insurance policy with the change, then a legal problem would develop which could be difficult to resolve.