You made a great decision to get coverage, but don’t screw it up with your life insurance beneficiary choice.
One of the most important decisions you make with life insurance is choosing your beneficiary.
What is a life insurance beneficiary?
A beneficiary is a person, trust, or entity designated to receive the life insurance benefit when the insured dies.
Who gets to choose the beneficiary?
The owner of the policy gets to make beneficiary decisions.
As part of the application and underwriting process, you will choose your beneficiaries.
Our Life Insurance for Dummies guide is a great place to start if you’ve never applied before.
There may be rare instances where a court order (divorce) or an irrevocable designation stops you from making changes, but otherwise, if you own the policy, you are the boss.
The process for choosing beneficiaries is the same whether you buy term life insurance or another type.
What are primary and contingent beneficiaries?
A primary beneficiary is first in line to receive the life insurance proceeds when the insured dies.
The primary beneficiaries are who you want to receive the money.
A contingent beneficiary only receives the proceeds if the primary beneficiary died before the insured died.
Your contingent beneficiary only receives the proceeds if the primary beneficiary has died and the insured is still alive.
The reason why you should name contingent beneficiaries is because of the Uniform Simultaneous Death Act.
Who can be a beneficiary?
Just about anyone, but choose carefully in order to ensure that the life insurance proceeds are received by the people you intended.
Examples of possible beneficiaries include:
The most common option is to name your spouse as your beneficiary, whether it’s your spouse, parents, children, grandchildren, etc. It all depends on what you’re trying to accomplish.
Common terms used when designating beneficiaries:
Per Stirpes – “by the branch” is a designation that may be used if you named beneficiaries, but also wanted the proceeds to go to the beneficiary’s heirs if the beneficiary died.
Per Capita – “by the person” designation. An example would be if you had three beneficiaries on your policy. The beneficiaries would each receive 1/3 of the death benefit. If one of the beneficiaries died before the insured, the proceeds would be split between the 2 surviving beneficiaries.
Trusts may be revocable or irrevocable.
A revocable trust allows the grantor to make changes at any time prior to death, while an irrevocable trust can’t be changed once in existence.
Trusts provide tax advantages and better control over life insurance proceeds.
Irrevocable trusts are often used as the owner and beneficiary for large estates.
Additional benefits of trusts as beneficiaries may include greater control, creditor protection, financial management, and more.
Your favorite charity may benefit by naming them the beneficiary of your life insurance policy.
In the ideal situation, the life insurance benefit is greater than what you would have donated if you had given cash to the charity.
In many business cases, the company may be the beneficiary of the policy.
This may be the case for buy-sell or key person agreements.
What is the Uniform Simultaneous Death Act (USDA) and does it matter to you?
The Uniform Simultaneous Death Act (USDA) is a law enacted to deal with simultaneous deaths from an inheritance standpoint.
If it can’t be established that one person died before the other person by 120 hours, the USDA deems that each person predeceased the other.
Why does this matter?
A typical example is when a husband and wife buy life insurance and name each other the primary beneficiary of their policies.
They also name contingent beneficiaries.
If the coupled died simultaneously in a car accident, the USDA says that the husband died before the wife and the wife died before the husband.
The effect is that the primary beneficiary died before the insured according to USDA, which means that the life insurance proceeds will be paid to the contingent beneficiaries listed on the policies.
Do Beneficiaries Pay Taxes on Life Insurance?
The good news is that most death benefits are tax-free to beneficiaries.
Of course, there are exceptions to this, but that mainly involves some business life insurance or estate planning policies.
You should always ask your accountant or attorney about tax questions.
The good news is that many beneficiary mistakes can be fixed.
The policy owner controls the policy and has the ability to make changes in most cases.
The following are mistakes to avoid.
Naming Your Minor Child as Beneficiary
When you name your minor child as the beneficiary of your life insurance policy, there will be delays.
A court proceeding will need to take place, a guardian will be named to manage the insurance proceeds until the minor child reaches adulthood.
Naming Your Estate as Beneficiary
Life insurance proceeds are generally received tax-free, but that could change when you name your estate as your life insurance beneficiary.
If left to your estate, your policy proceeds will go through the probate process and be subject to court and administrative fees.
Mixing Beneficiaries from First and Second Marriages
If you think it’s a good idea to put your ex-spouse and your current spouse as beneficiaries on the same policy, think again!
Get two policies with the ex-spouse on one policy and your current spouse on the other.
The same goes for when you have children from multiple marriages…get separate policies.
This one is just a common sense thing to do to avoid problems in the future among your beneficiaries.
Take your time when deciding on your beneficiary.
Keep in mind that you can make changes in the future if you are the policy owner.