How Do You Decide on a Life Insurance Beneficiary?

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What is a beneficiary?

Your life insurance beneficiary is a person who receives the proceeds of your policy upon your death. Policyholders often name their spouse, children, or parents as their beneficiary, but you can select anyone, including a church or charity.

If you want, you can have multiple beneficiaries. For example, if you are married but take care of your parents’ finances, you can name your spouse, mom, and dad as your beneficiaries.

Choosing your life insurance beneficiary is a crucial step in owning a policy. In fact, for most people, their beneficiary is the reason they are buying life insurance protection in the first place.

Types of beneficiaries

Life insurance beneficiaries can be primary or contingent. They can also be either irrevocable or revocable.

Let’s take a look at what these terms mean.

Primary Beneficiary

A primary beneficiary is the person or entity who receives the life insurance proceeds of your policy upon your death. You are free to choose anyone as your primary beneficiary and can designate more than one.

When naming multiple primary beneficiaries, specify the percentage (or the amount) of death benefit that you want each to receive. If you do not assign your beneficiaries to receive the life insurance death benefit, the life insurance company will distribute the life insurance payout equally.

Contingent Beneficiary

Contingent beneficiary — also called the life insurance secondary beneficiary — is the person or entity who receives the death benefit if your primary beneficiary predeceases you. You are free to choose anyone and can have multiple secondary beneficiaries to receive the death benefit. If there is more than one contingent beneficiary, specify how you want the proceeds to be distributed among them.

Life is unpredictable and things often do not go as we plan. For this reason, it makes sense to designate one or more secondary beneficiaries. If the primary beneficiary dies before you do, the insurer will issue the life insurance death benefit to the latter. The secondary beneficiary also receives the proceeds of your policy if your first beneficiary is untraceable.

Let’s say you purchase a $1 million life insurance plan with your spouse as the primary beneficiary. When you pass away, they will get the entire death benefit.

However, it is possible your partner will not outlive you. If that happens and you do not update your beneficiaries, your estate will receive the proceeds of the policy, and the payout will be subject to tax.

The executor of the estate will first use the payout to pay off estate taxes or other legal fees associated with the estate settlement. The remaining money will then be distributed among your heirs as per your will. In other words, the entire death benefit will not be distributed among your heirs.

In contrast, when the death benefit is issued to one or more individuals as a lump sum, the payout is not subject to tax. By naming contingent beneficiaries you can ensure your policy’s entire face value is distributed among your loved ones.

Furthermore, if you would rather have the death benefit distributed directly between your two children, designate them as secondary beneficiaries.

Irrevocable Beneficiary

An irrevocable beneficiary enjoys certain guaranteed rights to a life insurance policy’s death benefit. You cannot change an irrevocable beneficiary without their consent. For this reason, policyholders do not usually prefer irrevocable designations. However, naming someone — like a child — as an irrevocable beneficiary can make sense if you want to ensure that the payout reaches that person.

Revocable Beneficiary

A revocable beneficiary does not have any guaranteed rights to a policy’s life insurance payout. You are free to change a revocable beneficiary as you wish since you do not need their approval

Tips for choosing a beneficiary

Specifying who will receive the proceeds of your policy is an important decision. Since the life insurance company issues payout after your death, here is how you can make sure your final wishes are carried out.

Here are some tips to keep in mind when naming a life insurance beneficiary.

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Tip #1: Determine who you want to help  

Whom you should name as the beneficiary depends largely on why you are buying the policy. Do you want to set up a safety net for your family? In that case, your spouse is the obvious choice.

If you are helping aging parents financially or are taking care of a disabled uncle, the death benefit can help them stay afloat after you are gone. When more than one person depends on you financially, splitting the policy amount among them might be the best thing to do.

Are you a single parent? Then choosing a life insurance is a must, since it ensures your child will be financially protected, no matter what. Think about who would take charge of your kid if something were to happen to you. The guardian can use the payout to cover your child’s needs and save money for their future. Alternately, you can set up a trust for your child and name it the beneficiary.

And if you are single with no dependents, you can turn the life insurance into a charitable gift. If you are passionate about a cause — saving the environment or educating the underprivileged children — designating a related group as the beneficiary is a good option.

Tip #2: Know the options available to you

You do not have to name an individual as the beneficiary. A trust, a charity, or your estate can also be designated as your beneficiary.

Naming a trust as your life insurance beneficiary makes sense when:

• You have minor children or dependents and want someone to manage the payout on their behalf
• You want to ensure the proceeds of the policy are used only for specific purposes (like for childcare or college education) or saved for a specific period
• You do not want any disagreements in the event of divorce

Naming the estate as the beneficiary — while possible — is something that you should avoid. That is because in this case the payout is taxable. Which means your heirs will receive less money than you intended them to inherit.

Tip #3: Avoid naming a minor as the beneficiary

Before you name a beneficiary, consider their age. While you can name a minor as the beneficiary, the law prevents insurance companies from writing a check to minors.

If your beneficiary is not yet an adult when you pass away, the court will appoint a guardian to manage the proceeds of your policy until your child reaches adulthood. This court process involves fees, which can be avoided by naming a trusted adult as the beneficiary.

Alternately, if you have a living trust, you can name it as the beneficiary of your policy. The trust manager will manage the payout for your child until they legally become an adult.

Tip #4: Consider naming multiple primary beneficiaries

Sometimes, choosing more than one beneficiary might make sense, like when you have multiple financial obligations to family members. When designating multiple beneficiaries, specify how much of the death benefit you want each to receive.

You can do this by assigning percentages of the benefit to each beneficiary (e.g. 50% to your spouse and 50% to your children) or by listing the exact figure each will get.

Additionally, you must specify whether you want the money to be distributed per capita or per stripes.

Per Capita

In the per capita distribution, all designated beneficiaries receive a payout only if they outlive you. If a beneficiary dies before you do, their share is distributed among the remaining beneficiaries.

Let’s say you have your three sons — Mark, Greg, and Rooney — as your beneficiaries. You want each to receive an equal share (33.33%), but Mark predeceases you. In this situation, the life insurance company will distribute Mark’s share equally between Greg and Rooney. So, instead of 33.33% each will receive 50% of the death benefit.

Per Stripes

In the per stripes distribution, if a beneficiary predeceases the insured, their share is split equally among their surviving descendants.

Continuing with the above example, let’s say Mark is survived by two daughters — Laura and Sydney. They will receive Mark’s share instead of it going to Greg and Rooney. That means Laura and Sydney will receive one-sixth of the benefit amount, while Greg and Rooney will get one-third.  

Tip #5: Name a contingent beneficiary

Designating a contingent beneficiary helps keep the death benefit out of probate. It also ensures you have control over who receives the proceeds of your policy.

When you die, the life insurance company issues the payout to the first beneficiary. If the latter does not outlive you, the money goes to the contingent beneficiary. When there is no contingent beneficiary, the proceeds become a part of your estate, which can complicate things.

Your estate can be subject to probate — a legal process of distributing the deceased’s assets in the absence of the will. A judge will decide who receives the payout. The probate process usually takes several months. Moreover, it can affect the final amount disbursed since there are legal fees that your estate must pay.

For these reasons, it is always a good idea to have one or more contingent beneficiaries.

Tip #6: Keep your beneficiary designations up-to-date

You should review your beneficiary designations periodically, especially if there is any change in the family status, like marriage, divorce, or death of a loved one. Keeping this information up-to-date ensures the money goes where you want it to go.

You should review your beneficiary choice once a year or whenever you experience a major life event. Common life situations when you may want to change your beneficiary or beneficiaries are:

• When you get married
• When you get divorced
• When you have children (or more children)
• When you assume responsibility for a loved one, like an aging parent or relative
• When your kids reach financial independence
• When a loved one passes away

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Tip #7: Take the beneficiary’s circumstances into account

It is possible that your decision to name an individual your beneficiary may create problems for them. Say you want to name your niece, who has a disability and receives monetary benefits from the government, as the beneficiary of your life insurance policy. However, if she receives a payout and her income exceeds a certain threshold, her benefits could be reduced or even suspended.

Therefore, if your beneficiary needs to avail such benefits after your death, ensure the inheritance will not affect their ability to receive them.

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Tip #8: Keep the language of the life insurance policy in mind

You can name your life insurance beneficiary by their name or by class. The second option, however, can sometimes create problems. Say you write “all children from this marriage” against the beneficiary name. In this case, any adopted child will not receive a payout.  

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Tip #9: Ensure your will matches your beneficiary choices on the life insurance policy

Your life insurance policy and will are two separate legal contracts. Updating your life insurance beneficiaries in your will is not the same thing as updating your life insurance beneficiary designations. In the event of a mismatch, the life insurance payout will be distributed as per the beneficiary designations on your life insurance policy.

For example, if your two children are named as your life insurance beneficiaries in your will, but your life insurance policy has your spouse’s name, the life insurance benefit will go to your spouse.

For this reason, make sure both your will and life insurance policy reflect your current wishes. If you make changes to your will, update your life insurance policy as well and vice-versa.

What happens if you do not have a beneficiary?

When you sign up for a policy, the insurer will ask you to name a life insurance beneficiary. This ensures the benefit amount reaches the intended person soon after your death.

If you do not designate a beneficiary, they are no longer living, or the insurer is unable to locate them, the payout goes to your estate and is distributed by your local probate court. Probate proceedings often take a lot of time and cost a lot of money.

Your heirs will not receive the payout immediately after your death, nor will they receive nor all of it. Moreover, there is always a chance the money will not go where you wanted it to, as many people may lay a claim to it. For these reasons, it is always recommended to keep your beneficiary designations up-to-date.

Conclusion

Your life insurance beneficiary receives the proceeds of your policy when you pass away. Designating the appropriate beneficiary is neither challenging nor complicated, and you are free to choose anyone to receive the benefit. However, avoid naming a minor child or your estate as your beneficiary because that can unnecessarily complicate the payout process.