Drafting Wills and Trusts: Be Careful Naming Life Insurance Beneficiaries

BY ROBERT MORGAN

It is not unusual for attorneys to use estate planning software or form documents in drafting wills and trusts as part of estate plans they prepare for their clients. These forms and software documents typically contain a boilerplate provision directing the personal representative or trustee to generally pay expenses of administration, taxes, and creditor claims of the decedent (hereafter collectively referred to as the “Clause”).

Throughout my many years of practice, I have never drafted a will or trust without including the Clause in the estate planning documents my office prepared. How can such an innocuous provision contained in a will or trust be a problem? I found out the hard way. I hope my experience dealing with the Clause helps you avoid defending yourself in a legal malpractice action. 

This article focuses solely on the subject of life insurance and its exemption from creditors’ claims; other assets with beneficiary designations, such as annuities, are not addressed. There are separate laws in Washington and other jurisdictions regarding assets like annuities. See RCW 48.18.430 for the general rules in Washington state. 

FACTS 

Assume you are retained to draft an estate plan for a client. The client prefers a revocable trust over a will as their primary planning document, having learned about the benefits of avoiding probate from watching YouTube videos and similar online sources. Note: Washington law permits non-intervention probates—meaning less time and money spent in probate after a testator’s death. In other states, such as Florida (where I practiced prior to relocating to Washington), which do not utilize non-intervention procedures, a revocable trust may be the preferred main estate planning document in order to avoid a long and expensive probate. In this case, one of the client’s significant assets is a life insurance policy (the policy). The client expresses a clear intent that the policy proceeds be distributed to a spendthrift sub-trust for the benefit of his children. A spendthrift sub-trust is a trust within a trust that, in this case, would hold a child’s inheritance and protect that inheritance from becoming available to the child’s or the decedent’s creditors. The assets of a revocable trust are generally subject to a decedent’s creditors’ claims to the extent the assets of the probate estate are insufficient to pay the same. See Section 733.707(3), Florida Statutes, for an example of such a law.

As an astute estate planning attorney, you suggest the use of an Irrevocable Life Insurance Trust (ILIT) to own and be the primary beneficiary for the policy. An ILIT is an irrevocable trust whose sole asset is life insurance. Since the trust is irrevocable, neither the decedent’s nor the decedent’s beneficiary’s creditors can attach the proceeds of the life insurance owned by the trust. The life insurance proceeds are protected from the claims of the trust beneficiary’s creditors. After discussing the fees involved to prepare this estate plan, your client rejects your suggestion of using an ILIT as too expensive. He wants a spendthrift trust for the benefit of his children, which is contained in the revocable trust you are retained to prepare (the sub-trust). 

You advise your client that, without the use of the ILIT, the beneficiary of the life insurance policy should be the sub-trust. You warn the client that it is possible, if naming the revocable trust as the policy beneficiary, that some or all of the policy proceeds may become available to his creditors at death, thereby causing less money to flow to his children. There is a statute indicating that life insurance is a creditor-exempt asset in probate and trust administration proceedings, but you find no cases in your research on this issue. You provide the client with written instructions on how to fund the revocable trust, including the exact wording that makes the sub-trust the beneficiary of the life insurance proceeds. 

Both the revocable trust and the pour-over will contain the Clause, which is the generalized direction to pay the deceased’s creditors’ claims.

At the time of the client’s death, your client had $6 million in assets (mostly consisting of real estate secured by mortgages and the proceeds of the policy) and over $8 million in creditor claims, most of which would be due to deficiency judgments due to the devaluation of the real estate assets. With the devaluation of the real estate, the only asset available to pay creditors’ claims is the proceeds of the policy. 

When your client dies, his children come to you to settle their father’s estate. You realize the client failed to follow your advice; he named the revocable trust as the beneficiary of the policy, not the sub-trust as you directed. Since the probate estate is insufficient to satisfy all of the creditors’ claims, some or all of the revocable trust’s assets may be deemed available to satisfy creditors’  claims.

AFTERMATH OF MOREY

In Morey v. Everbank and Air Craun, Inc., 93 So. 3d 482 (Fla. 1st DCA 2012), a Florida case of first impression, the facts of which I detailed above, life insurance proceeds payable to a revocable trust were deemed available to pay the claims of creditors of the settlor’s estate. I was the attorney for the decedent and his children for the drafting and subsequent administration of the revocable trust after my client’s death.

Both the trial and appellate courts in Morey ruled the general language of the Clause was sufficient to waive the creditor exemption for life insurance proceeds. In other words, a general statement to pay expenses and claims of a testator of a will or settlor of a trust is sufficient to waive the creditor exemption enjoyed by life insurance proceeds. 

Around the time Morey was decided, the courts in Arizona dealt with the same issue. In In re Estate of King, 269 P.3d 1189 (Ariz. Ct. App. 2012), an Arizona appellate court ruled the exact opposite of the Florida courts in its analysis regarding the availability of life insurance proceeds to pay a decedent’s creditors’ claims. On similar facts and law to those analyzed by the Florida courts, the Arizona courts found that a general provision to pay creditors’ claims was insufficient to waive a statutory exemption for life insurance to pay similar claims.

The Florida Bar Real Property, Probate, and Trust Law (RPPTL) Section felt the courts were incorrect in their ruling in Morey. Section members were worried about potentially thousands of estate plans being defeated and sued for malpractice based on the ruling. In its white paper¹1 www.rpptl.org/images/PT_2013_5.pdf. submitted to the Florida Legislature along with proposed language amending the relevant statutes, the Florida Bar RPPTL Section advised of its position that a specific waiver should be required to waive the subject life insurance creditor exemption.

A Florida Bar Journal article discusses the Morey decision and its impact on wills and trusts.²2 George D. Karibjanian, “Morey v. Everbank: Three Drafting Tips To Avoid A Troubling Decision,” Florida Bar Journal, Vol. 87, No. 7, July/August 2013 at 45. The author provides suggestions to “fix” the problem caused by the Clause as it was interpreted in Morey. In addition, the Florida Legislature amended the relevant statutes to state that without express language waiving a statutory exemption for life insurance proceeds, the general statement in the Clause to pay the estate’s creditors is insufficient to waive any permitted exemption provided in the statute. The new law had a retroactive effect. 

WHY WASHINGTON LAWYERS SHOULD CARE ABOUT THE CLAUSE

In Washington, it is common for life insurance proceeds to be exempt from an insured’s creditors so long as the beneficiary of the policy is not the decedent or his estate. See RCW 48.18.410 (2009); Washington Community Property Deskbook, Section 4.18 (2023).³3 While an experienced estate planning attorney can help their clients avoid such a scenario, it can still happen. Individuals and insurance agents regularly name an insured’s revocable trust as the beneficiary when completing life insurance policy applications. And many people today enlist the help of the internet, rather than an estate planning expert, to assist in drafting simple wills and trusts. 

However, since many Washington residents own real property and other assets subject to the laws of different jurisdictions, estate planning for only Washington asset protection may be insufficient to meet the goals of your client and fulfill their testamentary intent. Should an ancillary probate be necessary, the creditor exemption laws of another jurisdiction may differ from those in Washington. In addition, in my experience, clients often acquire assets after executing their estate planning documents without notifying their counsel. 

SUGGESTIONS FOR ESTATE PLANNING ATTORNEYS 

For the past several years, I have used the following language in my wills and revocable trusts to deal with the issue raised in this article:

Notwithstanding anything in this will or trust to the contrary, it is the settlor/testator’s intent that a general statement to pay claims, taxes, and expenses of administration, such as that found in Article____, shall not constitute a waiver of any laws providing creditor exemptions to any of the assets of this estate, including, but without limitation, life insurance proceeds. Any properly appointed fiduciary, such as my personal representative or trustee, may assert such exemption on my behalf to any court or administrative body with jurisdiction over my estate.

I also added a reformation provision for both judicial and non-judicial modifications in the event a court ruled that an exemption had been unintentionally waived.

In Washington, maintaining available creditor exemptions, such as for life insurance, is particularly important when you represent older clients. These clients may require Medicaid to pay for their long-term care costs, which can run from $10,000- $20,000 per month. Clients typically can’t pay this amount and require Medicaid assistance. Washington has a Medicaid recovery law, which means the state is required to try to get reimbursed for any sums it has paid out for an individual utilizing its Medicaid long-term care program. The recovery is usually accomplished at the time of an individual’s death by filing a creditor’s claim in probate. Making the beneficiary of the life insurance a third-party special needs or spendthrift trust is a way to ensure a surviving spouse and children receive an inheritance.

CONCLUSION

What I take away from all the cases and statutes analyzed for this article is that lawyers generally should not advise a client to name their estate or a revocable trust as the beneficiary of any life insurance policy. Better practice is to name as the primary beneficiary the specific sub-trust created in a will or revocable trust that your client intends to have the life insurance proceeds flow to. These sub-trusts usually take the form of either a spendthrift or third-party special needs trust. Since following this advice, I sleep better at night. 

NOTES

1. www.rpptl.org/images/PT_2013_5.pdf.  

2. George D. Karibjanian, “Morey v. Everbank: Three Drafting Tips To Avoid A Troubling Decision,” Florida Bar Journal, Vol. 87, No. 7, July/August 2013 at 45.

3. While an experienced estate planning attorney can help their clients avoid such a scenario, it can still happen. Individuals and insurance agents regularly name an insured’s revocable trust as the beneficiary when completing life insurance policy applications. And many people today enlist the help of the internet, rather than an estate planning expert, to assist in drafting simple wills and trusts. 

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