What is a life insurance beneficiary?
A beneficiary is a person (or entity like a charity or business) who will receive the life insurance payout if the insured dies while the policy is inforce (active).
The policy owner chooses the beneficiary(ies) and determines how much each beneficiary receives if there is more than one.
Can I name more than one beneficiary?
Yes, you can name more than one life insurance beneficiary. You also choose what percentage each beneficiary receives. In addition, you can designate how proceeds are distributed should a beneficiary die.
John Smith is married with two children. He and his brother also share duties caring for their elderly mother.
John Smith decides to buy life insurance. He wants to make sure his family is taken care of financially even if he were to die unexpectedly.
He buys a $500,000 term life insurance policy. He names his wife and brother as the two primary beneficiaries.
He sets up the policy so 80% of the death benefit ($400,000) goes to his wife and 20% of the death benefit ($100,000) goes to his brother.
In addition to primary beneficiaries, you also have the option to name contingent beneficiaries.
Primary beneficiaries are first in line to receive the death benefit payout. If the primary beneficiary(ies) has died or otherwise cannot accept the proceeds, then the contingent beneficiary(ies) is next in line.
Naming a contingent beneficiary isn’t required, but it’s a good idea. If your primary beneficiary dies at the same time as you or prior to you and you don’t have any contingent beneficiaries listed, the policy’s death benefit is paid to your estate and then sits in probate until the court decides where the money goes.
Who can be a life insurance beneficiary?
Your beneficiary(ies) can be a person or entity, like a charity or business, a trust, or your estate.
In most cases you can choose whomever you wish to be your policy’s beneficiary. However, if there is no obvious insurable interest then the insurance company may ask for an explanation as to why you chose that beneficiary.
Note: Insurable interest means the beneficiary would feel negative financial impact as a direct result of your death.
There are three parties on a life insurance policy: the policy owner, the insured, and the beneficiary. Policy owners should avoid these three parties being three different people to avoid unnecessary taxes.
John Smith owns a life insurance policy on his wife, Jane, and names their adult son, Brad, the primary beneficiary.
When Jane dies, John gifts a large sum of money (the death benefit) to Brad, from a government tax point-of-view. This gift will then be subject to tax if it exceeds federal limits.
Immediate Family Members
Naming a spouse or partner is the most common life insurance policy beneficiary. More than likely, they would suffer financially from your death.
The main purpose of buying term life insurance is to replace the income you provide to your family. If you die, your surviving partner/spouse receives a death benefit check from the insurance company.
When buying life insurance, you may have your children first in mind. Your children are completely dependent on you for many years.
However, you should not name any minor children as your life insurance beneficiaries.
If you die and they are not yet legal adults, the court will appoint a property guardian to manage these funds until your children reach legal age. This court process requires attorney fees, court proceedings, and court supervision of life insurance benefits – all of which take time and money.
If you want the life insurance money to go to your young children, instead name a trusted adult as the beneficiary to manage the money on your children’s behalf.
Or open a living trust, name the trust the life insurance policy beneficiary, and a trustee can manage the money on your children’s behalf according to the terms to lay out in the trust.
Or you have the option to name your minor children as your life insurance policy beneficiaries under your state’s Uniform Transfers to Minor Act (UTMA).
If your children are already legal adults, you can name them as life insurance beneficiaries without issue.
Charitable organizations and small businesses are entities that are commonly named as life insurance beneficiaries.
To name a charity as a beneficiary, you’ll likely need to show that you have a history of contributions to the organization. Also be sure to tell the organization that they are a beneficiary or else how will they know to collect the benefit if you die?
A business can be named as a beneficiary in buy-sell agreements and key-person insurance plans. Life insurance can be beneficial in many situations for a small business owner.
There are some situations in which it may be better to name a trust as a beneficiary to a life insurance policy instead of an individual.
Naming the trust instead of an individual may be best if your beneficiary:
- Is a minor
- Has special needs or a disability
- Has creditor issues
- Has alcohol or drug abuse problems
- Cannot be trusted with large sums of money.
With a trust, you can specify when and how much your loved one can receive. A trustee you choose manages the funds according to your wishes.
In the majority of cases, it’s not wise to name your estate as the life insurance beneficiary. It increases your overall taxable estate. In addition, money in an estate goes through probate court before your loved ones receive it.
However, if you do not name any beneficiaries or if your named beneficiary dies prior to or at the same time as you and you haven’t named any contingent beneficiaries, your estate is often the default beneficiary. This is why it’s recommended to designate at least one contingent beneficiary.
What information will I need?
When completing the beneficiary designation form, you’ll typically need the following information about your beneficiary:
- Full legal name
- Birth date
- Relationship to you
- Taxpayer ID number or SSN
But not all life insurance companies require the same information.
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Can I change my beneficiaries?
Yes, as policy owner, you can change your beneficiaries even after the policy is inforce (active). You can also change what percentage they receive.
Note: Beneficiaries cannot change their status on a policy. They can decline the payout if they want, but they cannot change the amount they receive. Nor can someone make themselves a beneficiary on a policy they aren’t named on. In addition, the insured and policy owner aren’t always the same person. Only a policy owner can name and change beneficiaries. The insured cannot (unless they are the policy owner as well).
Exceptions to the Rule
In most cases, a policy owner can change their beneficiaries at any time. However, if the beneficiary is declared revocable or if you reside in a community-property state then you cannot make changes so easily.
A common situation of a beneficiary being designated as irrevocable is in the case of divorce settlements. A court may judge that you need to keep your ex-spouse as a beneficiary due to alimony or child support responsibilities.
If you and your spouse reside in a community-property state and you purchase a life insurance policy while married and living in that state, your spouse may have legal rights to 50% of the death benefit, even if you do not list them as a beneficiary.
Changing your policy’s beneficiary is as easy as filling out a form and sending it to the insurance company. The tricky part is to remember to do so.
Because life brings many changes, we recommend you review your life insurance beneficiaries annually to ensure your policy is still aligned with your wishes and goals.
Mistakes to Avoid
To conclude, let’s review with a quick overview of things not to do when choosing life insurance beneficiaries.
- Don’t choose a minor as a beneficiary.
- Don’t name someone who receives needs-based government benefits, such as Medicaid or Supplement Security Income, as a beneficiary.
- Avoid the policy owner, insured, and beneficiary being three different people.
- Avoid naming only one beneficiary.
- Don’t forget to review and update your beneficiaries as needed.
Your beneficiaries will need to send in a claim for the benefit, but if they don’t know a policy exists, all of your planning to protect them will have been in vain.