Naming a life insurance beneficiary is one of the most important decisions to make when buying a policy. Your beneficiary is the person or entity that will receive the proceeds of the policy upon your death. Oftentimes, beneficiaries are chosen based on personal or business reasons.
Because of the potential financial, legal, and tax consequences relating to choosing a beneficiary, it is essential that policyholders pick carefully and avoid making simple, yet costly mistakes.
Primary and Contingent Life Insurance Beneficiary Designations
In life, things can and do change. With that in mind, it is possible that the person you name as your life insurance beneficiary could pass away before you. For this reason, the best life insurance companies allow you to pick different levels of beneficiaries as back-ups.
The three different types of designations include:
- Primary Beneficiary – The primary beneficiary (or beneficiaries) is the individual or legal entity that you have chosen to receive the death benefit first. If this beneficiary is alive and available at your death, he will collect the policy proceeds.
- Contingent Beneficiary – The contingent beneficiary, also known as the secondary beneficiary, is the next in line to receive the policy proceeds. The contingent designation collects no payout if the primary is still alive when the insured person dies. Just as with the primary, there can also be more than one contingent.
- Tertiary Beneficiary – Finally, you can choose a third level. The tertiary beneficiary will receive the policy proceeds if both the primary and secondary beneficiaries are unavailable.
You will want to be sure that you review your life insurance policy and beneficiary designations on a regular basis. Life changes, such as marriage, divorce, death, the birth of a child, or a change in your business, can require a need to amend the beneficiary on your policy. To do so, you will need to contact your life insurance company and complete all necessary paperwork.
Revocable and Irrevocable Life Insurance Beneficiaries
Life insurance beneficiaries can further be broken down into two special classes – revocable and irrevocable.
- Revocable Beneficiaries – You have the right and ability to change the beneficiary to your life insurance policy without the consent or knowledge of the previously named beneficiary.
- Irrevocable Beneficiaries – If you’ve named an irrevocable beneficiary, you may not change the designation without the consent of the previous beneficiary.
Most life insurance experts recommend you only use the revocable option to avoid legal issues in the future.
Choosing A Life Insurance Beneficiary: The Different Kinds
It is not necessary for your life insurance policy beneficiary to be a human being – you can pick a legal entity such as a business, charity or trust. Your options include, but are not limited to, the following:
- Individual or Family – Immediate family members who are financially dependent on you should top your list of potential beneficiaries. Policyholders can choose a spouse or domestic partner, children, step-children, parents, brothers and sisters, or any member of the family.
- Estate – The proceeds from a life insurance policy can be left to your estate. The death benefit amount will be paid to the Executor or Administrator of the estate to be used as he sees fit – usually to pay for estate taxes or financial assistance to dependents. However, your estate’s Executor or Administrator must also be named in your last will and testament, and approved by the probate court.
- Trusts – You can name a trust as your beneficiary. Life insurance trusts are legal entities used for estate planning purposes. Depending on the type of trust that is set up, the proceeds from the policy may or may not even be included in your taxable estate. If the proceeds are not included, this could potentially save your loved ones a great deal in estate taxes.
- Charity – You may choose to donate by naming a charity as either the primary or secondary beneficiary.
- Business – When businesses or partnerships purchase key person life insurance, the business itself becomes the beneficiary of the policy.
What If You Want To Name Multiple Beneficiaries?
In addition to having a choice in who will be your policy’s beneficiaries, you can also choose how the proceeds will be split. For example, if you have a surviving spouse and child and want them both to receive an even share of the payout, you can specify that the funds be equally divided between them.
In these situations, policyholders should ideally assign a percentage rather than a dollar amount because the amount of the death benefit may increase or decrease due to investment gains, earned interest, fees, etc. Using percentages prevents a potential legal battle over payout amounts.
In naming multiple beneficiaries, there are two different approaches that you can take – per stirpes or per capita method.
An estate is distributed per stirpes if each branch of a family receives an equal share. When using per stirpes, you can designate the beneficiaries via your family line. In other words, the proceeds will be passed down and equally divided among your surviving children, and then among their surviving children.
Example: You assign your son (Aiden) and daughter (Sophia) as equal beneficiaries. Unfortunately, your son dies before you do. If you pass away, Sophia would receive 50% of the death benefit while the remaining 50% would be evenly distributed to Aiden’s surviving children.
Alternatively, if you use the per capita method, the policy’s proceeds will be distributed equally among all of the survivors.
Example: In the scenario above, suppose Aiden had 3 children. The policy proceeds would then be divided evenly between Aiden’s 3 children and Sophia, with each individual receiving 25% of the total payout.
It is also extremely important to specifically state your beneficiaries by their full name rather than generic terms such as “wife” or “children”. To further avoid any confusion, you may even include their date of birth and Social Security Number.
A Guide To Naming A Beneficiary, Legally
While there aren’t any rules to picking a life insurance beneficiary, here is a list of “Do’s” and “Don’ts” when determining who will get your money.
- Always choose a primary and secondary beneficiary. Include their full name(s), date of birth, and/or social security numbers.
- Don’t use generic titles such as “spouse” or “children”.
- Review your life insurance policy every few years, especially after life-changing events such as marriage, death, divorce, or the birth of a child/grandchild.
- Don’t list minors as recipients unless they have legal guardians.
- Assign percentages rather than dollar amounts.
- Don’t name your estate if there are specific family members you want to gift. Your creditors may be able to file claims against your estate.
- Don’t name a creditor as a beneficiary.
Naming a life insurance beneficiary should be an easy, straightforward process. Nevertheless, be sure to carefully consider the reasoning behind all of your choices and consult your accountant, financial planner and attorney to discuss the legal, financial and tax implications.