Life Insurance Beneficiaries 101

Designating life insurance beneficiaries seems straight forward, but it can be tricky. There are common mistakes made in choosing beneficiaries. These mistakes can be expensive and sometimes heartbreaking. When there is a mistake, you have not created a problem for yourself but for the loved ones you leave behind at your passing. A beneficiary designation is just as crucial as choosing the best life insurance company.

The primary beneficiary is the person who first would receive the death benefits of an insurance policy. The contingent beneficiary will receive the proceeds of the insurance policy if the primary beneficiary is deceased. You can also have multiple primary and contingent beneficiaries on a life insurance policy. Beneficiaries can be revocable or irrevocable.

When the owner and the insured are the same, generally acceptable beneficiaries, include any beneficiary designation that benefits the Owner/Insured or the Owner/Insured’s dependents or community. Acceptable beneficiaries may consist of persons with whom the Owner/Insured is in a close relationship, and the Owner/Insured wishes to leave that person a legacy or expects that person to use the death proceeds to cover the Owner/Insured’s final expenses.

Examples of Acceptable Beneficiaries Include:                                               

• Wife, husband, domestic partner, common-law spouse, fiancée
• Son-in-law, daughter-in-law
• Children, stepchildren, grandchildren
• Sibling
• Niece or Nephew
• Aunt or uncle
• Parent or grandparent
• Certain Charitable Trusts
• Irrevocable Life Insurance Trusts
• Qualified charitable or community organizations

 Naming Children as Life Insurance Beneficiaries

Parents use life insurance to provide financial security for their children if one or both die unexpectedly. However, listing a minor child as a beneficiary isn’t always the best approach.

Life insurance companies won’t pay life benefits directly to a minor if minor children are beneficiaries of your policy. If no legal arrangements for a guardian to manage the money on their behalf, the court will appoint one for you.

That process necessitates attorneys’ fees, court proceedings, and court supervision of life insurance benefits. All of which incur costs and hassles that surely won’t help your children financially after you are gone.

Instead, it’s best to set-up a trust to benefit the child and name the trust as the beneficiary of the policy or name an adult custodian for the life insurance proceeds under the Uniform Transfers to Minor Act. The Uniform Transfers to Minors Act (UTMA) allows a minor to receive gifts, such as money, patents, royalties, real estate, and fine art, without the aid of a guardian or trustee. Under the UTMA, the gift giver or an appointed custodian manages the minor’s account until the latter is of age.

Multiple Life Insurance Beneficiaries

 You can undoubtedly designate multiple beneficiaries of each type for your policy. For example, you can have two primary beneficiaries and three contingent beneficiaries. Or you can have five primary beneficiaries and no contingent beneficiaries. There are no limits to the number of beneficiaries you designate if each one has an insurable interest.

Insurable Interest

A life insurance beneficiary is a person or entity that will receive the proceeds of your life insurance policy die. As the owner of the life insurance policy, you can usually name anyone you want. However, an insurable interest must exist for a beneficiary named in your policy. An insurable interest is a relationship in which one party will suffer financial loss in the event of your death.

When you purchase a life insurance policy, there must be an insurable interest between you and the person whose life you are insuring or designating as your beneficiary. Insurable interest protects against someone who has no interest in your life profiting from your death.

Selecting Multiple Beneficiaries

When choosing multiple beneficiaries, you’ll need to make sure the percentage split between all recipients in a category totals up to 100 percent. If you designate one primary beneficiary to receive 50 percent of the death benefit, the remaining primary beneficiaries combined must receive the remaining 50 percent.

If married, most people name their spouse beneficiary but don’t consider the spouse might predecease them.  What if death occurs to you and your spouse at the same time? When there is no living beneficiary, the life insurance benefit typically goes into the estate and is subject to probate. If this happens, the heirs might have to wait to receive the life insurance benefits. Benefits previously protected from creditors can now be open to creditors’ claims.

Secondary and Final Beneficiaries

It is essential to name the secondary and final beneficiaries. If the primary beneficiary dies before you do, then the money passes to the secondary beneficiary. If the secondary beneficiary has passed away when you die, then the death benefit goes to the final beneficiary.

When you list the beneficiaries, be specific.  Instead of stating to “divide the benefits evenly among surviving children,” list their names and date of birth, some companies require social security numbers. Otherwise, the insurance company will have to conduct a search, which can take a lot of time. One company was so lax in naming beneficiaries that upon the death of the insured, the beneficiaries were not able to be located. Heavy fines on the company changed that practice.

Other Possible Life Insurance Beneficiaries

The insurance company may request an explanation of the purpose of the insurance and how it is of benefit to the Owner/Insured or the Owner/Insured’s dependents):

• Family-owned business
• Employers or business partners

Unacceptable Life Insurance Beneficiaries       

1. Funeral homes

2. Lending institutions

Consider collateral assignments to the lender or creditor of the amount owed by the Owner/Insured

The Danger of Improper Life Insurance Beneficiary Designations

If a beneficiary is not named, it may result in the death proceeds paid to the estate of the Owner/Insured. Life insurance proceeds left to the Owner/Insured’s estate may cause death taxes, court costs, and other fees. If the Owner and the Insured are not the same, State laws and regulations may vary, creating different rules around acceptable beneficiary designations.

But there is an exception to be aware, improper ownership and beneficiary designations can cause the death benefit to be considered a gift tax by Uncle Sam. Most people are unaware of a tax surprise called the “Goodman Triangle.” The unexpected can happen when three different people are the policy owner, insured, and beneficiary.

Review Your Life Insurance Beneficiaries

With time, I have been amazed that clients do not remember who the beneficiaries of their insurance policies are. It would seem that everyone would know who they named, but they amazingly many do not. If the primary beneficiaries are known, many have forgotten who the listed contingent beneficiaries are in their policies.

You are not locked into your beneficiary designations forever. It is easy to change your initial life insurance beneficiaries. Remember, you can change your beneficiaries as often as necessary throughout the life of the policy. However, only the policy owner can do this. The policy owner and the insured person are often ones and the same, but not always.

It is just as important to review the contingent beneficiaries. They are essential also. Again, if the unthinkable happens and you and your primary beneficiary die in a single accident, the contingent becomes the beneficiary of your life insurance proceeds. Be sure to take the time to review the beneficiaries that you have on your policies.

Factors to take into consideration that may require a beneficiary update, are marriage, the birth of a child, divorce, and the death of named beneficiaries. Life moves forward, and beneficiaries need to be updated. Beneficiaries should be reviewed every three years or after significant life events, such as having children, marriage, or divorce. When circumstances change, beneficiaries need replacing. Unfortunately, many forget to do so.

Use an Independent Agency Rather Than a Captive Agent

A captive agent is just that, captive! They must offer only products from the company that has “captured” them. Unfortunately, this limits your choices at finding the best company that fits your situation. Many larger agencies that regularly advertise also only represent a handful of companies. The key to finding the best term life for physicians is to use an agency that represents multiple term life insurance carriers.

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