Choosing your beneficiaries, who are the people or entities who receive the benefits when you die, is arqueably the most important part of owning life insurance.
However, picking this recipient may not be as easy as you imagine. After all, state laws and policy rules can limit your options. Additionally, changing or correcting your beneficiary isn’t as easy as switching bank accounts. As such, it’s imperative that you clearly understand how your life insurance company handles beneficiaries before committing to a policy.
Who can be a life insurance beneficiary?
Great question. Short answer? Pretty much anyone, such as
- A person, such as your spouse or partner.
- Multiple people, like your three children.
- A trust.
- Your estate.
- A charitable organization.
- A legal entity, like your company.
Depending on your insurer, you may only be able to designate a certain number of beneficiaries. When compiling your list, be selective if your policy has such a limit.
Primary and contingent beneficiaries.
Beneficiaries can either be primary or contingent. And, it’s important to know the distinctions of each.
Usually, your spouse, children, parents or other family members will be the primary beneficiaries of your life insurance policy.
At the same time, nearly all policies allow you to name a backup beneficiary, or a “secondary” or “contingent” beneficiary Why? It’s there just in case your primary beneficiary dies before or at the same time as you. In this case, the death benefit is paid to the secondary beneficiaries.
What happens if you don’t choose a beneficiary?
In the absence of a beneficiary designation, it may be unclear who is entitled to receive the funds, which can delay the payment of benefits.
A 401(k) account, for example, is held in probate if no beneficiary is named. This is an in-court process where a court determines how to distribute your assets if you die without a named beneficiary.
If you fail to name a beneficiary, most life insurance policies will pay the default beneficiary. If the policy owner is still alive and different from the insured, they will receive the death benefit, otherwise the estate of the owner will receive it. With most group insurance policies, your spouse should be ranked first, followed by your children, parents, and finally your estate.
A payout will be made to your estate if there is no default order in your policy.
If you appoint your loved ones as beneficiaries, you can avoid the lengthy and complex probate process, which may take years before your assets are distributed. And, if they have expenses that they can’t pay because they relied on your income, this could put them in financial trouble.
With all that out of the way, here are the top 10 tips you should use when choosing a life insurance beneficiary.
1. Ask yourself, “Who could benefit the most?”
When you choose a beneficiary, you’re making sure that your money will go to the right place. What’s more, these assets will bypass probate. That means that your loved beneficiaries will receive a payout before your will is executed.
If you’re buying a policy for the first time, consider why you’re doing so. Often, life insurance is purchased to provide a safety net for loved ones in the event of your loss. So, it’s suggested that you spend some time considering the financial repercussions that your death will have on the people in your life.
A spouse is a natural choice, for example, if you’re married. The funds received from either term life insurance or permanent life insurance can be used by your spouse to cover day-to-day expenses. They can also use it to cover any remaining debts you had. In addition, if you have children, it’s a good way to help assist with extra expenses, such as college tuition.
What if you’ve been helping older parents financially or a disabled relative? In that case, the payout could keep them living comfortably after you pass away. Just note that if in this circumstance, it would be wise to name multiple beneficiaries and distribute the payout among them however you see fit.
The key takeaway here? Beneficiaries must have an insurable interest in the insured person. That’s just another way of saying that the beneficiary should have legitimate financial interest with you. Because of this, that’s why a spouse or children are usually named as beneficiaries since they rely on your financially.
2. Know your options.
Did you know that you have more choices than your spouse or children when selecting a beneficiary? In fact, you can name any one or more of the following individuals as a beneficiary;
- One person
- Two or more people (you decide how the benefits are split)
- The trustee of a trust you’ve established
- A non-profit or charity
- Your estate
- A legal entity, like your company
As soon as you decide who you want to be your beneficiary, make sure you give your life insurance company as much detailed information about that person as possible. At the minimum, this includes;
- Their full name
- Social Security number
- Birth date
- Phone number
- Description of the relationship you have with that person.
Having this information will make it easier to contact the beneficiary and avoid any misunderstandings.
Following your decision about who will receive the death benefit, the next step is to figure out how it will be paid out. You should seek legal counsel or a financial advisor’s assistance if you have multiple beneficiaries.
3. Decide how it will be distributed.
If you have a life insurance policy, you can name more than one person to receive death benefits. If you go this route, it’s imperative to determine how the proceeds of your life insurance policy will be distributed.
There are two main choices when it comes to how benefits will be distributed. Knowing the difference will help you decide how benefits will be allocated.
The simpler of the two is Per Capita distribution. Here the policy’s benefits are distributed equally to everyone you name as a beneficiary. If, for instance, you wish to distribute a third of the payout among your three children regardless of how many heirs each has, this would be your best option.
However, the other option, called Per Stirpes after the Latin word for “branches,” has its own advantages that deserve mentioning. In the case of a per capita distribution, if you have children and one of them dies before you, their families would not receive benefits. Rather, beneficiaries who are still living would collect the benefits.
According to Per Stirpes distribution, however, all branches of the family would receive benefits evenly. Thus, you’ll be able to provide for your grandchildren in the event that their parents would pass before you do. In the event that a beneficiary died, the children would receive an equal amount of their parent’s proceeds.
You can appoint a grandchild as the beneficiary instead of your child if you prefer. If the grandchild is a minor when they become insured, there can be additional contingencies.
4. Select a backup.
What if your primary beneficiary dies before you, can not be located, or refuses to receive the proceeds? To address this, you should always have a backup beneficiary. If you name a secondary beneficiary, your death benefit will be distributed directly to that individual.
5. Organize protection for minors or legally disabled.
Naming your children as beneficiaries on your life insurance policy might seem logical as a parent. However, if you die while they’re minors, they won’t be able to access the funds until they reach the “age of majority,” which is usually 18. If they need this money to take care of essential expenses, this delay can be frustrating. Moreover, it could put them in a precarious financial situation.
The good news? It is possible to avoid this issue and make sure your children receive the death benefit earlier;
- Appoint a guardian. Legal guardians of minors can receive payouts on behalf of their children in many states. Prior to your death, you can name a legal guardian, or a guardian may request rights afterward. A state must grant the guardian legal rights to manage the child’s finances, regardless of the situation. Consult a lawyer before appointing a guardian, as the process can be lengthy and expensive.
- Establish a trust. Leaving money to children through a trust can be very effective. It is possible to create a trust for your children, and you can have the trustee manage the funds according to your instructions. A trust must be valid and active when your death occurs. And there will be additional costs involved.
What if you want to name special needs and other lifelong dependents as a beneficiary? Just be aware that while you have good intentions, it could make them ineligible to receive government assistance.
If your assets or life insurance death benefit are being given to someone with special needs, you may be able to do so without triggering laws that could work against them by establishing a special needs trust and naming the trust as beneficiary. To learn more about your options, contact an attorney specializing in estate planning.
6. Use specific language.
You can list beneficiaries by name. Or you can designate them by class, which is a group such as “grandchildren of the insured.” Whichever method you choose, complications can arise.
Let’s say that you list your grandkids by name on your policy. But, you didn’t update it when your youngest grandchild was born. Is so, they won’t be able to receive a share of the proceeds upon your death. In contrast, an adopted child might not receive his or her share of the payout if your beneficiary is “all children born from this marriage.”
7. Ability to manage money.
What if your beneficiary isn’t the best at managing their money? If so, you may be leary about naming them as a beneficiary. The good news is that you can set up a trust and name a trustee to manage the funds on the beneficiary’s behalf.
8. Don’t forget your will.
The beneficiary designations on your life insurance policy will almost always prevail over the will. You should make sure your will and your life insurance policy match so that your wishes are honored. Furthermore, you can’t use your will to modify your life insurance policy. Therefore, if you name someone as a beneficiary of your life insurance policy, they will receive its death benefit regardless of what’s in your will.
9. Get acquainted with your state’s laws.
Your spouse will need to sign a waiver if you live in a community property state. If you reside in such a state, you and your spouse are equally entitled to any income earned during the marriage, as well as any property or belongings you may have acquired during the marriage. Your life insurance policy will be considered community property if you use the income from the marriage to pay the premiums.
In short, the payout will at least be divided between you and your spouse. Community property states include the following nine:
- New Mexico
In Alaska, South Dakota, and Tennessee, couples have the option of elective community property laws, which means their joint property can be equally owned. Therefore, if you chose to follow community property laws during your marriage, your spouse must grant your life insurance policy beneficiaries their consent.
10. Don’t just set it and forget it.
“While a life insurance policy is a contract, it’s important to remember that it’s not set in stone,” writes award-winning investigative journalist Ed Leefeldt in Forbes. According to Amanda Wallace, the head of insurance operations at MassMutual, the policy is a living document as long as the policyholder is alive. It’s also possible for beneficiaries to be changed at any time via a form or online. Regardless, you should schedule an annual reminder in your calendar to make any updates.
What’s more, you may want to change your policy based on personal preferences. “For example, the child that steps up to the plate during an illness or injury while another sits the bench,” adds Leefeldt. Remarrying or divorcing can also result in change, especially when new children are involved.
When naming a beneficiary, there are two options;
- If the policy is revocable, the policyholder can change the beneficiary at any time.
- The other is irrevocable. Here once a name has been listed in the policy, it cannot be revoked.
Additionally, when a couple divorces, a settlement might stipulate that alimony or child support be paid by one or both spouses, as well as life insurance.
Again, it’s also a good idea to name contingent beneficiaries since your life can fluctuate and people can come and go. As mentioned above, if the primary beneficiary dies, these are people or organizations that will receive the funds. “This is something that should always be considered, especially if the spouse is a primary beneficiary, and the couple is growing old together,” he writes.
Although you ultimately get to decide the beneficiary, it’s an enormous decision. Because of this, you should take this decision lightly. “It makes a statement,” says Wallace, “and it’s part of your legacy.”