The main reason you buy life insurance is to financially protect the ones you love. Naturally, selecting your beneficiaries is a very important part of the process. The beneficiary you select will receive the policy benefit upon your death. But what happens if your policy’s beneficiary dies first or at the same time as you?
What is the difference between a primary and contingent beneficiary?
When choosing beneficiaries it’s important to understand the difference between a primary and a contingent beneficiary.
Note: A contingent beneficiary is also called a secondary beneficiary or back-up beneficiary.
Your primary beneficiary is who the insurance company will pay your death benefit to first. If the primary beneficiary has died or cannot accept the benefit, then the contingent beneficiary is next in line to receive the death benefit.
It’s vital to have both types of beneficiaries. If your primary beneficiary dies before you and you didn’t designate a contingent beneficiary, your death benefit reverts back into your estate. If you and your primary beneficiary die at the same time and you didn’t name a contingent beneficiary, your death benefit reverts back into your estate.
Most people want to avoid including life insurance policies in their estates for two reasons.
1. The value of the life insurance policy will be included as a taxable asset which may push your estate over the exemption amount.
Currently, the federal estate and gift tax exemption is $11.58 million per individual (for 2020). This is a very large amount that most people don’t need to be concerned about reaching. However, this exemption is set to drop down to $5 million after 2025. A life insurance policy added to the rest of your assets (house, cars, bank accounts, etc.) may easily exceed the $5 million exemption. Doing so will generate a large tax bill due to Uncle Sam. This bill is paid before money is paid to any heirs.
In addition, some states have state estate taxes. These are separate from federal estate taxes and the exemption amounts are much lower than the current $11.58 million mark. So even if you qualify for the federal exemption, your estate may still get hit with a state tax bill. For example, in the state of Minnesota, our exemption limit is about $3 million. A life insurance policy can easily push your entire estate over this number.
2. The life insurance policy will go through probate.
Probate is a public procedure. This means the value of your assets and their beneficiaries are listed in court records and anyone can see them.
Assets in probate are also open to creditors. If you have any debt, creditors can now take what they’re owed from the life insurance proceeds before the funds are passed to your heirs.
Probate can also take years to complete. The death benefit from the life insurance policy you purchased to financially protect your loved ones may end up not getting to them for a long time.
Normally, life insurance death benefits are exempt from probate and creditors but not if it ends up in your estate.
What if I want more than one life insurance beneficiary?
You can name multiple life insurance beneficiaries. When you select more than one beneficiary, you can designate different percentages to each. The percentages need to add up to equal 100.
- Jane Doe (wife) 50%
- Andrea Smith (sister) 40%
- Animal Humane Society (charitable institution) 10%
If you do not specify percentages, the insurance company will divide the death benefit evenly between the multiple primary beneficiaries.
If you have more than one primary beneficiary and one of the beneficiaries dies prior or at the same time as you, then the death benefit will be split between the remaining primary beneficiaries unless you specify per stirpes or per capita.
Designating per stirpes or per capita takes your beneficiary’s children into consideration. Per stirpes means the deceased primary beneficiary’s share of the death benefit is passed on to his or her children. Per capita means the total death benefit will be split evenly between the surviving primary beneficiaries and the deceased primary beneficiary’s children.
John names his four adult children (Sam, Alan, Louis, and Jennifer) his life insurance policy’s primary beneficiaries per stirpes. Jennifer dies and John doesn’t update his beneficiaries. A year later, John dies. Jennifer’s children, Danny and Jordan, split her share of the death benefit. This means Sam, Alan, and Louis each receive 25% of the death benefit and Danny and Jordan each receive 12.5% of the death benefit.
John names his four adult children (Sam, Alan, Louis, and Jennifer) his life insurance policy’s primary beneficiaries per capita. Jennifer dies and John doesn’t update his beneficiaries. A year later, John dies. Jennifer’s children, Danny and Jordan, are entitled an equal share of the death benefit. This means Sam, Alan, Louis, Danny and Jordan each receive 20% of the death benefit.
In the case of having multiple primary beneficiaries, contingent beneficiaries only receive the death benefit if all of the primary beneficiaries are deceased.
John names his four adult children his life insurance policy’s primary beneficiaries and his favorite charity as the contingent beneficiary. Coming back from a family vacation, John and his four children tragically die in a plane crash. The entire death benefit of John’s life insurance policy goes to the charity.
On the rare occasion that you do not name a contingent beneficiary and you have no heirs for probate assets to pass onto, the life insurance death benefit escheats to the state you live in. In layman’s terms, this means the state gets possession of the funds.
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Choosing a Secondary Life Insurance Beneficiary
Your secondary, or contingent, life insurance beneficiary is simply a backup in case your primary beneficiaries are unable to receive the death benefit. Keep in mind: if you want someone to receive a portion of your death benefit, they need to be a primary beneficiary. A contingent beneficiary receives the death benefit only if all of your primary beneficiaries are unable to.
Your spouse and adult children are typical primary life insurance beneficiaries. Siblings and favorite charities are great secondary life insurance beneficiary options.
Does my beneficiary need to do anything?
When you buy life insurance, let your beneficiaries know. They will be responsible for starting the claims process when you die. Life insurance companies have millions of customers. They don’t automatically know when one of them dies.
Filing a life insurance claim is fairly straightforward. Understanding it yourself may help you prepare your beneficiary on the basic steps required.
- Contact the insurance agent who sold the policy or the employer if the coverage was through a group life policy.
- Obtain a copy of the official death certificate. If you are filing a claim on your spouse, you may need a copy of your marriage license as well.
- Complete a claim form from the life insurance company.
- Submit the claim documents and death certificate to the life insurance company.
Reviewing and Updating Your Life Insurance Policy
It’s important to review your life insurance policy every year and when you have major life changing events. Not only is it important to make sure you have adequate coverage, but also to make sure you have your beneficiary designation updated if needed.
Examples of when to review or update your life insurance policy:
- If you’re getting married or divorced
- If you’re buying a home
- If you’re having a baby
- If you’re making changes in employment
- If you’re taking out a new loan
If you’re the owner of a life insurance policy, you can make life insurance beneficiary changes at any time unless it’s irrevocable. An irrevocable beneficiary has rights to a life insurance policy. The policyowner would need this person’s authorization to make any changes. This is common in divorce agreements. In general, however, the policyowner can make beneficiary changes at any time.
To recap – selecting your primary and contingent beneficiaries is just as important as owning a life insurance policy. When you make the decision to protect your loved ones from financial disaster, make sure you understand how life insurance works, how funds will be distributed, and be sure to let your beneficiaries know they are included on your life insurance policy. You don’t want your death benefit to go unclaimed when you thought you were taking care of your loved ones.
If you don’t already have a life insurance policy in place, take a minute to run a free, no obligation term life insurance quote. Here at Quotacy, we don’t even ask for any personal information until you are ready to apply. A Quotacy agent is waiting to help you through the life insurance buying process.