RJP Estate Planning Blog

How Does Life Insurance Fit Into Your Arizona Estate Plan?

Life insurance isn’t just a policy; it’s a strategic tool to protect family finances, equalize inheritances and keep business plans on track.

Short Answer

  • Life insurance proceeds usually bypass probate and pay directly to the named beneficiary A.R.S. § 14‑6101.
  • Avoid naming minors outright; courts require a conservator to manage significant funds for children Maricopa County Guardianship Guide.
  • Policies can replace income, pay debts, equalize inheritances and fund business buy‑sell agreements.
  • Trusts and proper beneficiary designations control how and when benefits are used.

Why life insurance matters in estate planning

Insurance creates liquidity when cash is needed most.

When you die, your family may face final expenses, debts and ongoing bills. A properly structured life insurance policy provides a tax‑free death benefit that can replace lost income, pay estate expenses and cushion your loved ones through the transition. Unlike bank accounts or real estate, life insurance pays promptly if beneficiaries are named and claims are filed correctly.

  • Income replacement: Term life insurance can replace a breadwinner’s income for spouses and children.
  • Debt and taxes: Proceeds can pay off mortgages, medical bills or estate taxes so heirs don’t have to sell assets.
  • Charitable giving: Naming a charity as beneficiary leaves a legacy and may reduce estate taxes.
  • Liquidity for estate settlement: Insurance provides cash to your executor or trustee, avoiding forced sales of illiquid assets.

Types of life insurance

Know your options before you buy.

Life insurance generally falls into two categories: term and permanent. Term insurance covers you for a set period, such as 20 or 30 years, and is often used to replace income while children are young or debts are high. Permanent insurance, including whole life and universal life, offers lifetime coverage and accumulates cash value that can supplement retirement income or fund future premiums. Business owners may also use key person or split‑dollar policies to protect business operations.

How much coverage do you need?

Let your goals, not rules of thumb, drive the numbers.

Deciding how much insurance you need depends on your obligations and goals. Add up outstanding debts, planned education costs for children, estimated funeral expenses and the income your family relies on. Subtract existing savings and other resources. Many advisors suggest coverage equal to ten to fifteen times annual income, but your situation could require more or less. Revisit coverage amounts periodically as debts shrink and children become independent.

How life insurance pays out

Designating beneficiaries keeps policies out of probate.

Arizona law treats insurance beneficiary designations as nonprobate transfers. A provision in a policy directing the insurer to pay the death benefit to a named person is nontestamentary A.R.S. § 14‑6101. This means the proceeds pass outside of your will and trust and the insurer pays them directly to your beneficiary without court involvement. Always name primary and contingent beneficiaries, and review them after major life events to avoid unintentionally naming an ex‑spouse or deceased person.

What if no beneficiary is named?

If you fail to name a beneficiary, the policy proceeds become part of your probate estate and may be subject to creditor claims. Updating beneficiary designations on life insurance, retirement accounts and payable‑on‑death bank accounts is a critical part of keeping your plan current.

Avoid naming minor children directly

Minors can’t legally control assets—courts must appoint a conservator or trustee.

In Arizona, a minor receiving more than $10,000 in property or annual income usually needs a court‑appointed conservator Maricopa County Guardianship Guide. Naming a child as beneficiary on a life insurance policy can delay access to funds and require court oversight until they turn 18. Instead, consider:

  • Creating a revocable living trust and naming the trust as beneficiary. Your trustee will manage funds according to your instructions and distribute them at appropriate ages. Learn more in our living trusts guide.
  • Using an irrevocable life insurance trust (ILIT) if estate tax planning is a concern. An ILIT owns the policy, keeping the proceeds out of your taxable estate and protecting them for beneficiaries.
  • Establishing a UTMA (Uniform Transfers to Minors Act) account with a custodian, but remember the child gains full control at the age of majority.

Also beware of naming a guardian in your will and assuming they can access insurance money—without a trust or UTMA arrangement, the guardian may have to petition the court to manage the funds for the minor’s benefit.

Equalizing inheritance and providing liquidity

Use insurance to treat heirs fairly and avoid forced sales.

Life insurance can balance your estate when one child inherits a business or farm and others receive cash. Proceeds can also provide cash for buy‑outs, home repairs or education while other assets remain invested or illiquid. In blended families, insurance ensures children from a prior marriage are provided for without disinheriting a new spouse.

  • Equalize value: If you leave a business to one child, use insurance to give other children comparable value.
  • Cover taxes and debts: Large real‑estate or retirement accounts may trigger taxes at death. Insurance provides liquidity to pay those obligations without selling assets.
  • Support special needs beneficiaries: Pair insurance proceeds with a special needs trust to supplement care without disqualifying government benefits.

Funding buy‑sell agreements and business succession

Business owners need liquidity to keep the company running.

Buy‑sell agreements funded with life insurance guarantee that a surviving partner can purchase the deceased owner’s interest at a predetermined price, protecting the business and the deceased owner’s family. Choose between cross‑purchase arrangements (owners buy policies on each other) and entity‑purchase agreements (the business owns the policies). Coordinate policy ownership, premiums and beneficiaries with your attorney and CPA, and link your buy‑sell to your overall estate plan.

What happens after divorce?

Arizona law automatically revokes certain designations for an ex‑spouse.

Under Arizona’s revocation‑upon‑divorce statute, divorce revokes revocable beneficiary designations that name a former spouse A.R.S. § 14‑2804. This includes beneficiary designations on life insurance policies, wills and trusts unless the governing instrument provides otherwise. After divorce, review and update your beneficiary designations, trusts and powers of attorney to reflect your current wishes. If you remarry, new designations will revive these rights.

Tax considerations and planning

Proceeds are income‑tax‑free but may be subject to estate tax.

Life insurance death benefits are generally free of income tax to beneficiaries. However, under federal law the proceeds are included in your taxable estate if you own the policy or have “incidents of ownership” at death 26 U.S.C. § 2042. Large estates may need an ILIT to remove the policy from the estate. Work with counsel to determine whether federal estate tax could apply and how to structure ownership and premium payments.

Remember that Arizona currently has no state estate tax, but federal estate tax applies to estates above the federal exemption amount. Paying premiums through an ILIT ensures the policy’s death benefit remains outside your estate while still providing for heirs.

What to do next

Review your coverage, beneficiaries and trusts now.

  • Inventory your existing life insurance policies and check beneficiary designations.
  • Consider whether your beneficiaries include minors or individuals with special needs who would be better served by a trust. See our trust funding guide.
  • If you own a business, review or draft a buy‑sell agreement funded with insurance.
  • Consult with your estate planning counsel and your insurance professional to determine appropriate coverage amounts and policy types.
  • Update your plan after major life events like marriage, divorce, childbirth or retirement.

Get Help Tailoring Your Plan

Our team can review your policies, beneficiary designations and trust structure to make sure your loved ones are protected.

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FAQs

How much life insurance do I need?

There’s no one‑size‑fits‑all number. Start by adding up outstanding debts, anticipated funeral and estate costs, and the years of income your family would need if you died unexpectedly. Many advisors recommend coverage equal to ten to fifteen times your annual income. Adjust the amount as your debts shrink or your financial responsibilities change.

Can I name my living trust as the beneficiary of my life insurance?

Yes. Naming a revocable living trust as the beneficiary allows your trustee to manage and distribute the proceeds according to your instructions, which is especially useful for minor children or blended families. Make sure the trust provisions specify how and when the trustee should use the funds.

What is an irrevocable life insurance trust (ILIT)?

An ILIT is a special trust that owns your life insurance policy. Because you no longer own the policy, the death benefit is removed from your taxable estate. The trustee must follow strict rules about paying premiums and distributing funds. ILITs are useful for large estates facing federal estate tax or for families wanting creditor protection for beneficiaries.

What happens to life insurance after divorce in Arizona?

Divorce automatically revokes revocable beneficiary designations naming your former spouse A.R.S. § 14‑2804. After a divorce, review and update your beneficiary designations to reflect your new situation. Naming contingent beneficiaries or trusts ensures the policy still pays out as intended.

Are life insurance proceeds taxable?

Life insurance death benefits are generally income‑tax‑free for beneficiaries. However, if you own the policy at death, the proceeds may be included in your federal estate 26 U.S.C. § 2042. To avoid estate tax inclusion, consider using an ILIT or transferring ownership of the policy during your lifetime.

Key legal sources