HOW TO CHOOSE A LIFE INSURANCE BENEFICIARY
Life insurance is crucial in protecting your hard-earned assets and ensuring your final wishes are met. But choosing a life insurance policy that meets your needs is only the first step. The second? Choosing a beneficiary.
Choosing a beneficiary is one of the most important decisions you’ll have to make when you buy a life insurance policy. It’s the person who will be getting the payout of your death benefit, after all!
Many people are happy to name their spouse as beneficiary. It makes sense, of course. Who better to receive your death benefit than the person you chose to spend your life with?
Naming your significant other isn’t always the right course of action, however. In some cases, you may be better off naming a child, grandchild, or even a third party as your beneficiary.
Who to designate as your beneficiary is dependent on a number of factors:
- Why you’re covered by life insurance
- What kind of life insurance you’re covered with
- Who will honor your final wishes
Let’s talk about choosing a beneficiary, what their responsibilities are, and who’s the best choice for each situation.
WHAT IS A BENEFICIARY?
Simply put, a beneficiary is the person, people, or organization that will receive the death benefit of your life insurance policy. Not assigning someone as your beneficiary means the proceeds of your life insurance will pass to your estate.
A beneficiary is one of the few ways to pass money tax- and probate-free to a loved one. If the death benefit goes to your estate, it could get tied up in an expensive and lengthy probate process.
WHO CAN BE A BENEFICIARY?
Your beneficiary could be anyone, but that doesn’t mean that anyone should be your beneficiary. Many choose to designate their spouse or significant other as a beneficiary. Some may even name a child or grandchild.
Some business owners may elect to name their business partner as a beneficiary. Other policyholders may make a gift of their death benefit to a cherished charity or church.
There are two types of beneficiaries for you to designate: primary and secondary.
Primary beneficiaries are those who will receive the death benefit upon your passing. You may choose one or more people as primary beneficiaries.
If you have multiple primary beneficiaries, it’s wise to assign them a percentage of your policy’s death benefit — not a specific dollar value. Some policies’ death benefits may be larger than the face value you originally purchased. So, assigning each a percentage of the proceeds can help avoid a legal battle.
Of course, the total percentage of all primary beneficiaries must equal 100 percent.
Secondary or Contingent Beneficiary
Secondary (also called contingent) beneficiaries receive the proceeds of your policy if there are no more surviving primary beneficiaries.
If, for example, your primary beneficiary is your spouse and you both pass away at the same time, your death benefit would be awarded to your secondary beneficiary. If none is assigned, your money would pass to your estate and be subject to probate.
PER STIRPES VS. PER CAPITA
Don’t worry — despite sounding like lawyer talk, the concept of per stirpes vs. per capita is fairly simple.
When you designate multiple beneficiaries, each will be entitled to whatever portion of the death benefits you’ve assigned them. But what if you’ve designated multiple primary beneficiaries and outlived some, but not all?
That’s where this concept comes into play.
If your beneficiaries are designated as per stirpes, then the death benefit would be awarded along branches of the family. For example:
Let’s say you have two primary beneficiaries, John and Sally, each with two children. Both John and Sally are given 50 percent of your death benefit upon your passing.
John dies before you do. With per stirpes, his children would receive an equal amount of his share of your death benefit — 25 percent each of the total death benefit. Sally would receive her entire share of 50 percent, and her children would receive none (because she’s still alive).
If your beneficiaries are designated as per capita, Sally would be awarded John’s portion of your death benefit. John’s children would receive none.
Be sure to define which method you prefer when you first purchase a policy or you review your beneficiaries. Some companies may default to per stirpes or per capita unless you’ve requested otherwise.
WHAT CAN GO WRONG WHEN DESIGNATING A BENEFICIARY?
Most beneficiary assignments are revocable. This means you can change who you’ve designated at any time. Of course, having the option to revoke a beneficiary doesn’t help after you’ve passed.
You need to put some thought into who you assign as your beneficiary. If you make the wrong choice, you may defeat some of the benefit of even owning a life insurance policy.
You Didn't Specifically Name a Beneficiary
When naming your beneficiaries, it’s recommended to actually name them. Don’t use loose terms such as “wife” or “my children.” Instead, specify full names, dates of birth, and social security numbers.
For example, if you were to get divorced and remarried, your ex-wife could potentially have a legal claim to the proceeds if you’ve designated “wife” as your beneficiary. This is, of course, entirely dependent on the specifics of your policy and if you live in a state with community property laws.
Including as much specific information for each beneficiary helps your insurer find them after you’ve passed, too.
You Named Your Estate as a Beneficiary
Naming your estate as your beneficiary could be a disastrous and costly choice. After your death, your estate — all your property and assets — goes through probate. Lenders may be able to claim a portion of your life insurance proceeds as theirs to settle debts.
Avoiding probate is integral if you wish for your death benefits to pass through to your beneficiaries probate-free. The money is available to them as soon as the insurance company receives the death claim and processes the proceeds.
Naming your beneficiaries in a will isn’t enough to bypass probate, either. Save your loved ones time and money by specifically naming them as your life insurance beneficiaries.
You Named a Minor as Your Beneficiary
On paper, it makes sense to name a minor as a beneficiary. After all, if you pass, you’d likely want your death benefits to be accessible by your children.
But children aren’t financial experts (and lack much legal authority to use the money as you’d prefer, too). Insurers won’t pay out death benefits to minors.
If you die with a minor named as beneficiary, a court will appoint a custodian to handle the funds in the minor’s stead. You can avoid this process by naming a legal guardian yourself.
Even still, a payout will be delayed until a court legally recognizes the guardian.
You can avoid all these issues by establishing a trust in your minor’s name. A trust will avoid probate and ensure the funds of your death benefit are handled responsibly.
You Named an Untrustworthy Beneficiary
Death benefits are not only probate-free, but they’re tax-free as well. Depending on your policy’s face value, your death benefit might be a sizable chunk of cash.
And there’s no rule for how your beneficiaries use that money.
You may own a policy with a $500,000 death benefit intended to pay for a grandchild’s college tuition. Guess what? In a worst-case scenario, your beneficiary could take that money and lose it all gambling.
Think carefully about who to choose as your beneficiary. You should trust them to carry out your final wishes and to responsibly handle the proceeds of your policy.
THE TYPE OF LIFE INSURANCE YOU OWN IMPACTS WHO YOU SHOULD CHOOSE AS A BENEFICIARY
Certain life insurance policies lend themselves to certain intents and purposes. You may even have more than one policy based on your specific needs of coverage.
Here’s the thing: there’s no hard-and-fast rule for choosing the perfect beneficiary each time. You must designate beneficiaries based on why you own each policy and what you’d like done with the death benefit.
Here are some considerations to keep in mind depending on the life insurance policies you own.
Whole Life Insurance
Whole life insurance is an effective way of paying for your final expenses, paying off remaining debts, or leaving a gift behind.
Naming a Beneficiary for Final Wishes
The cost of funerals continues to rise and whole life insurance is a great way to ensure your final wishes will be paid for in full.
If you intend for your whole life policy to cover your final expenses, your beneficiary should be someone who will fulfill your final plans.
The ideal beneficiary for this purpose may be your spouse or one of your children (though be sure to name contingent beneficiaries!).
Naming a Beneficiary as a Gift
The death benefits of a whole life policy can be used as a gift. You may leave behind cash to establish a college fund for your grandchildren or for your spouse to go on a vacation. You could also choose to name a charity as your beneficiary!
Of course, if you’re leaving a gift for a minor, be sure to name a legal guardian or trust as the beneficiary in their stead.
Term Life Insurance
Term life insurance is often purchased by those with expensive debts in their name, such as a mortgage or student loans. It’s designed to replace your lost income before you’ve had the opportunity to build substantial assets.
Just because you’ve died doesn’t mean your household expenses are lower. In fact, your spouse will still need to pay 75 to 80 percent of your current expenses. That’s a solid chunk of change for one person to handle all of a sudden — while coping with grief, no less.
It’s a good idea to name the person who’d be most financially-impacted by your loss as the beneficiary of your term life policy. The proceeds can be used as a buffer while they adjust to a new lifestyle and financial situation.
Final Expense Insurance
Final expense insurance is most often intended to pay for your funeral and related expenses. Policies often have small face values between $2,000 and $40,000 of coverage.
When designating a beneficiary for a final expense policy, consider someone who will honor your final wishes. Explain to them your desire for burial or cremation and what kind of service you’d prefer. Help them understand the estimated costs of your last wishes, too.
And don’t forget to tell them what you’d like them to do with any money left over, if any — perhaps a gift, donation to charity, or debt payment.
YOU CAN CHANGE BENEFICIARIES AT ANY TIME
Choosing a beneficiary isn’t irreversible or permanent. In fact, you can change a beneficiary at any time and for any reason — as long as you own the policy.
Simply contact your insurer for a change of beneficiary form. Fill out the form, submit it back, and you’re all set!
Of course, it’s a good idea to tell your new beneficiary that they’re listed as such on your policy. When you pass, they’ll know they’re entitled to the proceeds of your policy. They’ll also know what you intended to accomplish with your life insurance coverage.
CHOOSE THE RIGHT BENEFICIARY
Choosing the right beneficiary will ensure the life insurance policy you’ve kept in force serves the purpose you intended for it. You’ll also be able to rest easy knowing your loved ones will have the financial stability they need long after you’ve gone.