Life Insurance Beneficiary Explained
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UPDATED: Jul 9, 2019
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The first step in safeguarding your family’s financial future is obtaining life insurance. However, the task isn’t completed until you designate a beneficiary to collect the death benefit proceeds when you pass away.
By not doing so, your death benefit will go to your estate which will then be subject to taxes and probate and produce an unpleasant experience for your heirs.
Since you will not be the one who receives the death benefit after your death, it’s imperative that you understand what life insurance beneficiaries are, how to select one, and whom to name as your contingent beneficiary.
What Is a Life Insurance Beneficiary?
A life insurance beneficiary refers to an individual, entity, trustee, or estate designated by the policy owner to receive the death benefit proceeds upon the insured’s death. The beneficiary’s mission is to fulfill the insured’s request concerning financial matters. There are two types of life insurance beneficiaries:
- Primary beneficiary: A primary beneficiary is a person or organization who will be the first one in line to collect the death benefit when the insured passes away.
- Contingent beneficiary: A contingent beneficiary, also known as the secondary beneficiary, is the second one in line to receive the death benefit if the primary beneficiary is deceased.
How to Choose Your Beneficiary
The task of choosing a beneficiary is unique to the individual’s circumstances and the intimate people around him (children, spouses, parents). The question you may want to ask yourself when picking a beneficiary is: “Whom am I trying to protect by buying this coverage?” Let’s take a look at a few examples.
- You may have children and a spouse and are trying to safeguard their financial future should you die prematurely. Your spouse should be the primary beneficiary.
- Maybe you are trying to protect your business partner from paying an outstanding loan by himself if you were gone. Your business partner or a key person in your organization should be your beneficiary.
- You may be an elderly parent who lives with his daughter or son and doesn’t want to be a burden when you pass away. That daughter or son should be the beneficiary.
A rule of thumb: your recipient must always be someone you trust to do what you have intended to do with the money when you pass away.
Can I Name Multiple Beneficiaries?
Sure, you can. Most companies allow you to name as many beneficiaries as your heart desires as long as the share amount between all recipients equals to 100 percent.
For instance, if you have three children, you may distribute the death benefit equally between them, so it comes to 33.33 %, or you may elect to leave 40 percent to the oldest one and 30 percent for each of the remaining children.
How to Select a Contingent Beneficiary?
A contingent beneficiary is a backup person to collect the death benefit if the primary beneficiary is deceased or can’t be located. You want to pick out someone from the immediate family circle or someone who has your trust.
The obvious choice for a primary beneficiary is the spouse and children, but what happens if no one survives due to a car accident? You may want to choose your will guardian to be your contingent beneficiary or one of your siblings.
Be Aware of These Mistakes When Naming a Beneficiary
Since most of us avoid contemplating our death, we tend to procrastinate the purchase of life insurance or buying and forgetting about it so that we can get back to doing “happy things” and proceed with our lives.
By not paying attention to small details or fine print in the policy, you are not creating problems for yourself. You are creating problems for your heirs who need to collect the death benefit proceeds.
Let’s find out the most common mistakes people are doing when naming a beneficiary and how to avoid it.
1. Naming a Minor Child
This is probably the most common mistake clients make when buying life insurance. Truth be told, this mistake is made by most individuals who choose to buy a policy by themselves. A good broker will advise them to avoid this slip.
An insurance carrier will not pay the death benefit directly to minors. If you didn’t establish a third-party fiduciary (trust) or an adult to administer the proceeds, the carrier would have to keep the money until the child turns 18 or 21 years, depending on the state.
2. Forgetting to Update
It goes back to dodging everything that has to do with life insurance. You demonstrated to your family that you love them dearly by safeguarding their financial future and obtained an insurance policy, but you set it aside and forgot to review and update it every few years.
For instance, what if you got divorced and remarried after a few years, but your ex-wife is the primary beneficiary of your life insurance? Make sure to review your policy every few years or after a significant event occurs (having a child, getting divorced, etc.).
3. Keep It Silent
The life insurance death benefit goes to your beneficiaries, not yourself. Hence, you are not doing any favors by keeping it a secret. Avoid the turmoil now by letting them know that they are the beneficiaries. By not doing so, you risk them never claiming the death benefit which defies the purpose of obtaining a policy in the first place.
Make sure to also identify them correctly on the application with their correct spellings, dates of birth, and social security numbers. You want to make sure they can collect the death benefit without paying court and attorney’s fees later.
4. Getting Taxed
Life insurance proceeds are generally paid to your heirs tax-free unless, of course, you weren’t aware of this fact: If you set up your policy in which the first person is the policy’s owner, another is the insured, and the third one is the beneficiary, the IRS may consider this as a gift and may impose a tax.
For instance, if you bought a policy on your wife, where you are the owner and named your son as the beneficiary, you just gave some money to Uncle Sam. A better solution is having your wife be the policy owner, and the insured while you and your son can be the primary and contingent beneficiaries.
5. Naming Irrevocable Beneficiaries
Revocable and irrevocable are two classes of life insurance beneficiaries. As a policy owner, you have full control over where the death benefit will go, the percentage amount, and the ability to change your designated beneficiary without his/her consent as long as it is a revocable beneficiary.
If, however, you choose to name them as an irrevocable beneficiary, you will not be able to alter any of the details stated above without their permission, which can create a nightmare later on. To keep things simple, make sure you choose revocable beneficiary so that you have full control over who should collect the proceeds.
Setting up your life insurance policy correctly the first time and reviewing it after a meaningful life event can give you peace of mind and avoid uncertainty, court fees, and your beneficiaries fighting over life insurance proceeds.
Life insurance isn’t a DIY project where you can save money by not using a broker. In fact, since prices are fixed by law, there is no incentive for you to do this alone. The prices are the same whether you purchase from a broker or buy directly from the life insurance company.
However, when you buy from a broker, you have someone on your side to assist you in avoiding the pitfalls and confusions by informing you when things aren’t done correctly.