Life insurance is a valuable tool to protect your loved ones financially once you’re gone. However, while there are several elements to pay attention to when filling out a life insurance policy, one of the most valuable components is the life insurance beneficiary.
Today, we want to take a deep dive into life insurance beneficiaries – who can be one, how they get paid, and how can you change them during the life of your policy. Figuring out your recipients is a crucial process, so you have to be sure you are making the right choice.
Who Can Be a Life Insurance Beneficiary?
When talking with your life insurance agent, you’ll want to come prepared with a list of possible beneficiaries. Also, keep in mind that you can name multiple people if you’d like. Any of the following entities can be named in your life insurance policy:
- One Person (i.e., a spouse)
- Two or More People (i.e., kids)
- A Trustee (when you’ve set up a trust)
- A Charity Organization
- An Estate
As you can see, you have plenty of options when dividing up the death benefit among your loved ones. Because you can name multiple people, it’s imperative that you calculate who should get what amount. You could distribute the funds evenly, or you can pick and choose based on a variety of factors.
One thing that you have to keep in mind is if you live in a state with community property laws. The states that have these laws include:
- New Mexico
In these states, you can’t name anyone other than your spouse as a life insurance beneficiary without their consent. In Alaska and Tennessee, community property laws are voluntary, meaning that you don’t have to opt-in if you don’t want. If you do live in one of these states, you will have to include your spouse in the beneficiary discussion if you are planning on naming anyone else in your policy.
Primary vs. Contingent Life Insurance Beneficiaries
When naming recipients of your death benefit, you’ll notice that there are two distinct classifications. Primary beneficiaries are the first people that will be notified and paid out upon your death. In many cases, your spouse and or your children will be named as primary beneficiaries.
If for whatever reason, the life insurance company cannot locate the primary person (or persons) listed because they may have predeceased you, the benefit will go to the contingent beneficiaries. What’s important to note is that contingent beneficiaries will not receive any funds as long as a primary beneficiary exists. Thus, if you want to distribute money between multiple people, make sure they are all named as primaries in your policy.
If you don’t have any contingents named, then the money will go to your estate instead. In any instance where a beneficiary cannot be found, life insurance benefits always go to the holder’s estate.
The issue with money going to an estate is that it can take a lot longer for the funds to be distributed. In this case, the death benefit will be subject to probate, where the courts will decide how the money will be given out and to whom. Not only that, but you may have to pay taxes on estate funds, which can diminish the amount distributed.
Another problem that you can run into is naming underage kids as life insurance beneficiaries. While you want the money to go to your children, they won’t be able to access it until they reach legal age. It can take some substantial paperwork for a death benefit to pay out before your kids turn 18, so keep that in mind.
Typically speaking, the funds will go into a trust with the child (or children) named as trustees. A fiduciary will manage the trust and pay out the money once the kids become eligible to receive it.
Revocable vs. Irrevocable Beneficiaries
In some cases, you might want to change your beneficiary during the life of your policy. This can happen for a variety of reasons. You have another child, you divorce and remarry, or your primary beneficiary dies before you do. Whatever the case, you need to make sure that you can name someone else if and when the time comes.
Revocable beneficiaries can be changed based on your input, meaning that you don’t have to notify them or get their consent. On the other hand, irrevocable beneficiaries need to confirm the change for it to take effect. For the most part, your agent will recommend making any recipient revocable, just in case.
Naming Beneficiaries Correctly
Although your children or your spouse may be the primary beneficiary on your plan, you need to be as specific as possible. For example, if you simply list “wife” or “husband” on the policy, an ex-spouse could potentially claim the benefit. Ideally, you will be able to provide a full name and social security number for everyone listed.
In the case of naming a business or other organizational entity, you will want to get tax information. This info can include an employer ID number (EIN) to ensure that the insurance company pays the correct business.
Realistically, you want to talk to your life insurance agent when setting up your policy to find out any particular details they will need to locate a primary beneficiary. Overall, more information is going to make the process a lot smoother and will provide financial relief that much faster.
Things to Keep in Mind With Beneficiaries
In most cases, naming a beneficiary will be a relatively straightforward process. For example, if you name your spouse, you should already have access to his or her information to ensure that the insurer can pay the benefit.
However, not all situations are the same. Here are some potential issues you can run into when figuring out your beneficiaries.
If your spouse or child receives disability benefits, getting a massive influx of cash from a life insurance payout could eliminate those benefits altogether. To make matters worse, the amount of money doesn’t have to be that much to create problems.
According to the Social Security Administration, anyone who receives $2,000 or more as a gift or inheritance is ineligible to continue disability benefits. Two thousand dollars isn’t enough to set up your beneficiary for a long time, but it can be enough to ruin his or her financial stability.
In these cases, you’ll want to set up a trust and name the person as a trustee. This way, the fiduciary can manage the funds and make sure that your beneficiary doesn’t receive too much to get kicked off of disability benefits. I would also highly recommend speaking with an attorney who specializes in this before making any decisions.
In most situations, death benefits from life insurance are not taxed by the government. However, if the owner of the policy, the insured, and the beneficiary are three separate people, taxes can and will apply.
As an example, let’s say that a husband takes out a policy on his wife and names their child as the beneficiary. If the wife dies, the death benefit is treated like a cash gift, which is subject to state and federal taxes. To avoid this problem, the best thing to do is have the insured own the policy (in this case, the wife).
Realistically, this issue shouldn’t come up, but be sure to talk to your agent about possible tax penalties when determining beneficiaries.
A crucial part of estate planning is creating and updating a will. However, you need to understand that anything listed in the will (including your life insurance policies) does not supersede anything contained in your insurance policy. Simply put, don’t assume that updating your will is the same as updating your life insurance beneficiary.
If you want or need to change a beneficiary, you will have to talk to your life insurance agent directly. Otherwise, any named beneficiary will still be on the policy, whether you want it or not.
As we mentioned, there can be a variety of reasons why your primary beneficiary could change. For example, perhaps your children have kids of their own, and you want to distribute the death benefit evenly among them.
We highly recommend checking in on your life insurance policy every year or so. Not only can your beneficiary change, but you may also want to adjust your coverage. In some cases, you may decide to reduce the death benefit because your children have grown up and moved out of the house. Overall, staying up-to-date with your plan is a smart move, so don’t neglect it.
Another component of updating your policy can be dividing money “per stirpes” or “per capita.” The former option shares the funds based on branches of the family, while the latter distributes it per person.
One way to look at the difference is if you want your grandchildren to receive part of your death benefit. Let’s say one of your kids has three grandkids, and the other only has two.
Under per stirpes, half of the money will go to each branch of the family, meaning that one side will have to divvy the money four ways instead of three. Under per capita, the funds are divided based on the number of recipients, so everyone gets an equal share.
You may want to write things out and do some math to determine which method will be right for your life insurance beneficiaries if this kind of situation applies.
For some people, talking about life insurance and death benefits can be a touchy subject. In some cases, you might decide to name a primary or contingent beneficiary without notifying the person beforehand.
Although you have your reasons for doing so, it can complicate things if and when a death benefit gets paid. If a recipient is unaware of the policy, he or she may never get to claim it, especially if the insurance company has trouble locating the beneficiary.
Overall, you want to be open and honest about your plans so that all of your beneficiaries can be aware of the situation.
How Your Life Insurance Beneficiary Can File a Claim
- Death Certificate – you don’t need the original; a copy will suffice
- Policy Document – make sure that beneficiaries can locate your policy paperwork, as the insurance company will require verification
- Claim Form – beneficiaries will have to contact the company to file a claim form, which differs between insurers
Death Benefit Payouts
There are two options when a beneficiary receives money from your life insurance. Either he or she can get a lump sum (usually tax-free), or get paid in installments. There are pros and cons to each method, but you can also determine how the money is paid out as well.
For example, if you want to make sure that your children don’t go crazy with a massive influx of cash, you could set up a trust that will distribute the money in monthly or quarterly installments. This way, your kids can maintain financial stability even though you’re not around to assist them.
In other cases, a lump sum could be better because it can be used to pay off substantial expenses like a car or home repair. Be sure to talk to your beneficiaries about these payment options to determine which will be best for them.
Potential Reasons for Claim Denial
In rare cases, your beneficiaries may not be able to get any money. Typically, these are the reasons why an insurance company might deny a claim.
- Insurance Fraud – if the insurer believes that the beneficiary isn’t legitimate, they can deny benefits (i.e., identity theft).
- Murder – if your beneficiary kills you, he or she won’t get any money from your policy
- Suicide – in most cases, insurers don’t pay life insurance for people who committ suicide
- Unlisted Disease – if you didn’t disclose any illnesses that contributed to your death, the insurer may stop payment
- Risky Behavior – in some situations, if you died doing something dangerous, it might not trigger a death benefit
Contact Us Today
Getting life insurance is one of the smartest things you can do for your loved ones. However, you need to make sure that your policy is in the best interests of your beneficiaries. Call us today or get a free quote to find out more about your options so that you and your family are covered for anything.