Owning a life insurance policy is a responsible way to ensure that your loved ones and your estate are well cared for once you die. One of the most confusing and difficult decisions you need to make is choosing a life insurance beneficiary. Broadly speaking, a beneficiary is the person or legal entity designated to receive the cash (death) benefits from the life insurance policy.
There are several types of beneficiaries, and it’s important to understand the differences. If you do not designate your beneficiary through the proper channels, then it can cause a lot of legal, emotional, and financial problems for your loved ones. Reading through this article will provide you with the background information you need to choose the right life insurance beneficiary.
Types of Life Insurance Beneficiaries
Primary beneficiary: The primary beneficiary is the person you name in your life insurance policy as the first to receive the cash (death) benefits. You may name more than one person as the primary beneficiary.
Contingent beneficiary: If the primary beneficiary dies before they are able to receive the cash payout, then the contingent beneficiary will receive the benefits. This term could also refer to the beneficiary who receives the insurance payout only if they meet certain requirements specified by the insured.
Revocable beneficiary: Most personal life insurance policies have a revocable beneficiary. This gives the insured the ability to change whom will receive the cash payout without the consent of the current beneficiary. They may also terminate the policy without consent.
Irrevocable beneficiary: In this type of life insurance policy, the insured may not change the beneficiary without his or her permission. The primary purpose for having an irrevocable beneficiary is to meet a financial obligation or to ensure that a named child would receive funds.
Key person life insurance: With this form of life insurance, benefits are provided to protect a company from the financial hardship that may result from the loss of a key employee due to a disability or death. There are several people that can be covered under this insurance: owners, founders, key workers, and top shareholders. Sometimes this is even required for small companies looking to get funding from investors. Under this plan, the business acts at the primary insurance holder and beneficiary. The premiums are paid by the business, but it also receives the payout if a key employee dies or is disabled. The payments received can be used to cover day-to-day expenses, money owed to investors, and debts.
Multiple Life Insurance Beneficiaries
Some plans allow you to name multiple beneficiaries. There are two options for distributing the cash payout:
Per stirpes: This method divides the money equally between branches of the family.
Per capita: This method divides the money equally between each person within the family.
Insure.com provides an excellent example to explain the differences between the two:
“Say, for instance, you want to leave the money to your two children, Bob and Sue, or to your grandchildren if Bob or Sue predeceases you. Bob has three children and Sue has one child. Now suppose Bob dies before you do.
Under per stirpes, half the money would go to Bob’s three children, and half would go to Sue. Under per capita, the money would be divided equally among Bob’s three children and Sue; each would get 25 percent.”
Different Life Insurance Beneficiary Options
Family: The easiest person to choose as the primary beneficiary is a family member, such as a spouse, child, or other relative. If you name your spouse, then much of your assets will be passed to them without being taxed. Speak with your local independent insurance agent as well as your lawyer to understand the spousal inheritance laws, as they vary from state to state.
Legal guardian: You may select a minor/child to be the primary beneficiary. If they are under the age of 18 or 21 when you die, then you also need to make sure you name a legal guardian on their behalf. Once the court has approved of the legal guardian, then the cash payout will be given to them.
Estate: You can name your estate as the beneficiary instead of a specific person. However, you can only do so if you have already drawn up a last will and testament. This is because the cash benefits of the life insurance policy will automatically go to the named executor or administrator of your will.
Trusts: Sometimes life insurance companies don’t allow the life insurance proceeds to go directly to a minor. You can set up a trust as the beneficiary instead of a specific person. This will leave the money to an adult who will watch over the trust until the child is of age.
Charity: Another option is to choose a specific charity as the primary or contingent beneficiary. If you are passionate about a certain cause, this is a great way to donate.
Mistakes to Avoid
- When you decide who you want your beneficiary to be, make sure to list their specific name(s). Don’t simply say “my wife” or “my children.” This makes the entire process incredibly convoluted and confusing for your lawyer when determining how to dole out your benefits.
- Your will is separate from your life insurance policy, so don’t just assume that the will beneficiary will automatically receive the life insurance benefits.
- Review your policy every few years. There may have been changes to your relationships, like divorce or having children, that may cause you to re-evaluate who you would like as your beneficiary.
- If your beneficiary dies before you, you need to name a new beneficiary as soon as possible. To do so, you should contact your insurance company and complete a “change of beneficiary” form. If both you and your beneficiaries die at the same time, then your assets would be defaulted to your estate. This will mean that your heirs will have to wait a longer amount of time to get the money.
- Have open lines of communication with your beneficiaries. Make sure to let them know that you have a life insurance policy and have named them to receive the cash payout. Also, let them know where the life insurance policy is located.
- If you decide to name a minor as the beneficiary, make sure you set up conditions for how the money will be dispersed once they become 18 or 21. Either set up a trust or list what the money can be used for (like college tuition) until they reach a certain age.
Speak with an Agent
Speak with your local, independent agent and attorney today. These professionals will have the knowledge and experience to help guide you through the process of choosing a beneficiary.
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