The beneficiaries are the most important aspect of life insurance, right? The whole reason you buy life insurance is to protect your loved ones from financial ruin if you died – those loved ones are the beneficiaries of your policy death benefit. Make sure your policy lists the beneficiaries and how you want the money divided correctly because you won’t be around to fix any mistakes if it’s not.
When it comes to naming beneficiaries of a life insurance policy, many aren’t aware of the options you have. You can leave the entire death benefit to one person, or even split between three individuals and a charity. Before you sign off on that policy, be sure to educate yourself on the naming of beneficiaries.
What are the different beneficiary levels?
There are many ways to distribute life insurance payouts. The most straight-up option is to have 100% of the death benefit going to one primary beneficiary. However, along with primary beneficiaries, you also have additional levels: secondary and tertiary.
Naming a secondary beneficiary (also known as a contingent beneficiary) means that he or she would be next in line for the payout if the primary beneficiary was unable to receive it.
John Smith has a $500,000 life insurance policy and names his wife primary beneficiary. John also names his brother as secondary beneficiary in case he and his wife die at the same time.
Naming a tertiary beneficiary would be the back-up if both the primary and secondary beneficiaries were unable to receive the death benefit.
John Smith has a $500,000 life insurance policy and names his wife primary beneficiary. John also names his brother as secondary beneficiary in case he and his wife die at the same time. John lists his local animal shelter as a tertiary beneficiary should both his wife and brother be unable to receive the death benefit.
While you’re only required to name a primary beneficiary, it’s always a good idea to name at least a secondary beneficiary just in case your primary predeceases you. If you only name a primary and this person dies before you do, then your death benefit proceeds revert back into your estate and likely goes into probate. The probate process can be lengthy and tie up your policy’s funds in the legal system for quite some time.
What are the different ways of distributing the proceeds?
You can leave 100% of the life insurance death benefit to one person or if you have a large family you can even choose to divide it into 10 equal shares of 10% – it’s up to you. When it comes to naming beneficiaries you also have a choice of assigning proceeds to be distributed “per stirpes” or “per capita”. These distribution options help the claims process if any beneficiary were to predecease the policyowner.
Per stirpes means that proceeds are divided by rank in the family and per capita means that proceeds are divided by the number of heads. Let’s see some examples for better clarification.
John has a $500,000 policy and names his three children Wendy, Michael, and George as primary beneficiaries to receive the proceeds per stirpes. In a normal scenario, Wendy, Michael and George would all receive a 1/3 share. However, what happens if Michael passes away before his father John? In a per stirpes scenario, if Michael has any children then those children would then split the 1/3 share that originally would have gone to Michael. If Michael does not have children, then Wendy and George split the proceeds 50/50.
John has a $500,000 policy and names his three children Wendy, Michael, and George as primary beneficiaries to receive the proceeds per capita. Let’s say Michael also has three children of his own. If Michael dies before his father John, then the proceeds are divided equally between Wendy, George, and Michael’s three children meaning each gets 20% of the death benefit proceeds.
Of the two options, per stirpes is more common because it covers the typical family situation. If you have a fairly large estate, be sure to work with an estate planning attorney to be sure you take care to avoid any unnecessary taxes. Also be sure to review your policy annually and with every important life event. Needs change, as do families, so taking the time for policy reviews is the best way to ensure what happens upon your death is exactly what you wish.
Photo credit to: William McMasters