No one wants to think about choosing a life insurance beneficiary. How do you make that kind of decision? If you have term life insurance, it may seem pointless to agonize over something that might not even happen.
Even if you have whole life insurance, which means the policy is good for as long as you live if you make the necessary payments, you likely don’t want to consider the circumstances under which it will be used. It seems mercenary, and no amount of money can replace a lost loved one, so why does it matter? We’ll cover how to select a beneficiary for your policy and why who you choose matters.
What Is a Life Insurance Beneficiary?
A life insurance beneficiary is the person or organization that receives the payout from a life insurance policy after someone passes away. A beneficiary can be a person, trust, charity, or estate. The money from a life insurance policy is referred to as a death benefit.
You can name several different parties as beneficiaries, and you will be able to determine what percentage of your policy goes to which party. For example, you might split the money evenly between your children or give half to charities and the remaining half to your spouse.
Are There Eligibility Requirements for Life Insurance Beneficiaries?
Determining who is eligible to be the beneficiary of your policy is a surprisingly complicated process. Technically, you have an insurable interest in yourself, which means that you can name anyone you would like as your beneficiary. Insurance companies still exercise discretion though, so someone usually has to have something called an insurable interest in the well-being of the policyholder to be eligible as a beneficiary.
An insurable interest doesn’t have to be financial, although it usually is. Any type of hardship suffered upon the passing of the policyholder can count as insurable interest. There is no clear definition of what hardship is, so your odds of convincing your life insurance company to name the beneficiary you would like are high.
Immediate family members, like your parents, siblings, spouse, children, and grandchildren are nearly always accepted as beneficiaries. Beyond your immediate family, circumstances get murky.
More distant family members, such as your nieces and nephews, typically aren’t shoe-ins as beneficiaries unless you can prove they would suffer a financial loss upon your death or some other hardship. Insurance companies tend to be understanding when it comes to selecting family members as your beneficiaries, even if they aren’t part of your immediate family.
Charities are generally considered eligible beneficiaries, although they have to be categorized as a 501(c)(3) nonprofit organization by the IRS. There are a couple of reasons you might want to choose a charity to get the payout from your life insurance policy.
The first reason to designate a charity as your policy beneficiary is that you believe in the work the charity does, and you would like to see their efforts continue even after you have passed away. Perhaps the charity had a big impact on your life, and you would like to honor that.
The other main reason to decide a charity should be your beneficiary is because you may be able to reduce or eliminate the federal estate tax. Most people won’t have to worry about an estate tax, though.
It generally only applies to individuals whose assets are worth over 11.58 million dollars, but if you’re one of the few who will be affected by it, having a charity as your beneficiary could save you thousands of dollars or more.
If you own a business, you may be able to list it as your beneficiary. In most cases, however, the business or your partners within the business will be the ones to take a life insurance policy out on you, rather than you naming it or them in a policy you own. As with all life insurance policies taken out by someone else on you, your consent is required for this to happen.
Insurable interest is meant to protect life insurance policyholders. Without it, life insurance would be about profiting from death rather than easing the worries of people in mourning.
Why Who You Choose as a Beneficiary Matters
The death benefit, or payout, that your beneficiary receives from your life insurance policy is meant to aid them financially when you pass away, which is the main reason who you choose matters. If you have aging parents who require care, children who are minors, or an adult child with special needs, you might want to name them as your beneficiary rather than other family members in your life who are more financially independent.
There’s also the fact that, when you name a beneficiary, the money doesn’t go to your estate. That means it isn’t available to pay for any debts you may have left, and instead will directly benefit the person or people of your choice.
Setting Up a Trust
Your beneficiary can do whatever they would like with the money they receive unless you set up a trust. In most cases, you probably feel your beneficiaries can make their own decisions. However, if there is anything specific you would like the money used for, setting up a trust ensures your instructions are followed.
There are also tax benefits to naming a trust as your beneficiary. When you do so, the trust technically owns your life insurance policy. This means it won’t be included when your assets are totaled. This can help reduce or avoid the estate tax.
What Happens if You Don’t Choose a Beneficiary?
While you could invest in a life insurance policy without picking a beneficiary, most people don’t. The entire purpose of a policy is to pay a person or organization should you die. So why wouldn’t you decide who?
If you don’t select a beneficiary, the money will go to your estate. From there a probate court will make the decisions about how to allocate it.
It’s more likely that the beneficiary of your life insurance policy will pass away before you do. Or that the insurance company will be unable to track them down or determine who you meant. If you say, for example, that the death benefit from your policy should go to your spouse, but you have had multiple spouses and don’t specify which, your ex-spouse could contest your policy. It’s important to be specific when choosing a beneficiary and to keep who you have listed up to date.
Naming a Beneficiary
Once you have decided who you would like to name as your beneficiary, doing so is simple. When you apply, there will be a section on the application that asks who you would like your beneficiary to be.
If necessary, you can then decide who will get what percentage of the payout. It’s best to use percentages rather than exact numbers when deciding who should receive what money. This is because the value of your policy may increase.
If that happens and you have stated exact amounts, your insurance company doesn’t have any instructions. They don’t know what to do with the money that is leftover. There could be a legal battle between your beneficiaries.
It’s best to use social security numbers to designate beneficiaries. That way, there’s no confusion over who you meant. Once that’s done, you don’t have to do anything else unless you would like to update your beneficiaries.
To change your beneficiary, ask your life insurance company for a beneficiary designation form. As soon as the insurance company has processed the form it will take effect.
Primary Versus Contingent Beneficiaries
There are two types of beneficiaries: primary and contingent. Your primary beneficiaries are the ones who will receive the money from the policy. Think of contingent beneficiaries as secondary, or backups.
If something happens to your primary beneficiaries and you haven’t updated any information, then the money will go to your contingent beneficiaries. Many people name charities or more distant relatives as contingent beneficiaries. Or, their children if their spouse is still alive to be their primary beneficiary.
What Your Beneficiaries Do
Beneficiaries don’t really have to do anything, which is good news. However, they may receive the death benefit more quickly if they file a claim with your life insurance company. It usually takes a month or two for the claim to be processed. But under some circumstances, it may take longer.
Your beneficiaries have the option of choosing how they will receive the death benefit. There are several options, the most popular of which is a lump sum payment.
The Right Life Insurance Beneficiary for You
Most people name their spouse or children as their life insurance beneficiaries. However, if you’re satisfied with who you have chosen, then they were the right choice for you. Charities, religious organizations, and other family members are also common choices.
Navigating life insurance policies, tax implications, and state-by-state law variations is exhausting and confusing. Many people choose to seek expert advice to ensure they’re making the best possible decision for their loved ones.
At NextGen Life insurance, we work with the best life insurance companies in the country to find you the best policy at the best price. We offer the same honest, unbiased advice we would give to members of our own families. Get your free quote today, or call us at 646-216-4199 to get started.