Choosing a life insurance beneficiary is equally essential as deciding what life insurance policy you want, so you should know some rules and formalities before signing the contract! We all need to be prepared for such a big step, so today we’re talking about:
- What is a life insurance beneficiary?
- Who can you choose to be a life insurance beneficiary?
- What is the difference between primary and contingent beneficiaries?
- What would happen if you don’t name a beneficiary?
- Beneficiary rules you have to know.
- The best way to support your family.
Let’s dive in!
What Is a Life Insurance Beneficiary?
A life insurance beneficiary is a person (or people) who chooses a policy owner to receive the death benefit if they die while the life insurance policy is still active. One of the top three reasons why people get a life insurance policy is because they have someone they want to support and finance even when they are gone.
However, even if it’s easy for you to name someone to be your life insurance beneficiary, there are many state laws and policy rules that can affect or even change your choices. Besides naming beneficiaries, you should specify how the life insurance benefits are to be handled if one or more beneficiaries can’t be found.
Before signing up the contract, read this article to be prepared!
Who Can Be a Life Insurance Beneficiary?
Choosing beneficiaries, and keeping those choices up-to-date is an important part of owning life insurance. You can name people, trusts, and organizations to be your beneficiary. Here is a list of the most common examples:
- A person (like your spouse or other family members)
- Multiple people (like children)
- A trust
- The estate
- A legal entity (company, for example)
- A charitable organization.
Make sure to check with your life insurance company what their rules are because some restrain the number of beneficiaries you can name. If there is a limit, be selective when compiling the list.
Every life insurance company requires that your beneficiaries have an ”insurable interest” in your life. By insurable interest, they think of people with more to lose than gain after the policyholder’s death. This is also why most insurers ask to write the type of relationship when filling the form (for instance, ”spouse”, ”domestic partner”, or ”friend”).
For your beneficiary to make a life insurance claim against your life insurance policy, they will need:
- Your death certificate
- The life insurance policy (or a copy),
- A claim form (from the insurer),
- The death certificate of primary beneficiary (if secondary beneficiary)
If you have multiple beneficiaries, each will need to submit a separate claim to the insurer to receive their portion of the proceeds.
Primary vs. Contingent Beneficiary
Primary life insurance beneficiaries are the first to receive the life insurance death benefit when the policyholder dies.
Contingent life insurance beneficiaries, or secondary beneficiaries, receive the death benefit if the primary beneficiary dies before the policyholder.
If the insured person decides to name multiple beneficiaries – whether primary or contingent beneficiary – they can choose how much of the death benefit each receives. For example, suppose the primary beneficiaries are a spouse, child, and a local charity.
In that case, someone can allocate 50% of the payout to their spouse, 30% to a child, and 20% to charity. No matter how people give their death benefit among beneficiaries, the percentages must add up to 100%. It’s important to list the rates because if you don’t, the insurer may grant an equal share to each beneficiary.
Irrevocable vs. Revocable Beneficiaries
Irrevocable life insurance beneficiary is unchangeable for designation without the beneficiary’s approval. A policy with an irrevocable beneficiary requires the policy owner to get the current beneficiary’s consent before making a change. Because of immutability, the irrevocable designation is uncommon.
Still, they can be beneficial when the policyholder wants to ensure the death benefit reaches a specific person. Irrevocable designations are commonly used in a divorce agreement to provide a former spouse isn’t removed from the policy without agreement. They’re also helpful in some business situations, like guaranteeing repayment of a loan.
On the other hand, a revocable life insurance beneficiary designation is flexible. A policyholder can change, update, add or remove a revocable beneficiary at any time. You have the freedom to update your designation to match your current needs or change your mind.
What Happens If You Don’t Name a Beneficiary?
When people don’t name a beneficiary, the insurer often issues the death benefit to their estate. Still, depending on the life insurance company, some insurers allocate the death benefit according to a specific order outlined in the policy.
This order can be different with different policies and life insurance companies, so you have to ask who’s first in line before you don’t name a beneficiary. For retirement plan like a 401(k), if a person dies without a beneficiary named, their assets will likely be held in probate court. In this legal process, a court has to sort out their financial situation and determine how to distribute their assets.
Community Property States
For people who live in a community state and were using money gained during the marriage to pay the life insurance premiums, their spouse may automatically be entitled to a percentage of the death benefit. In that case, people who want to keep this from happening must have the written consent of their spouse to the named beneficiary before they die.
Here is the list of states with community property laws: Arizona, California, Louisiana, New Mexico, Idaho, Nevada, Washington, Texas, and Wisconsin. States like Alaska, Tennessee, and South Dakota have optional community property laws which allow married couples to decide to have equal ownership of their joint property. The best thing is to review specific financial institution and their terms and conditions.
Life Insurance Beneficiary Rules You Have To Know
Few rules can affect and restrict your choice of a life insurance beneficiary on a policy you purchase. For example, a court will be involved if you name a minor as a beneficiary. A minor children can’t directly receive payouts from a policy, so the death benefit must first go to the minor’s legal guardian.
In case you didn’t name a guardian, the court will have to do it. This process can get really controversial and complex, so the recommendation is not to choose a minor as a beneficiary.
But, there is a solution for people who still want to do it. Many people avoid court involvement by setting up a trust as the beneficiary, and the trustee directs the money on behalf of the minor according to the policyholder’s wishes.
Another option is to designate a trusted adult as a life insurance beneficiary and include instructions in a will on how to use the life insurance proceeds to take care of the minor. Still, this also can cause problems and difficulties.
For example, the trusted adult doesn’t have a fiduciary duty to the minor, and creditors of the adult can access the death benefit. Therefore, it would probably be better to set up a trust if you want to have a child as a beneficiary.
Suppose you don’t have secondary beneficiaries, and your primary beneficiary dies. In that case, the death benefit will go to your estate, and they would be subject to probate, even if you have a will.
This means it could be disputed, and creditors can try to claim any debts the policyholder owns before the money is distributed to their heirs. But, the beneficiary designations trump what’s stated in a will. Therefore, the good advice is to review the policy’s beneficiaries yearly and ensure they reflect your wishes.
Spouse As a Beneficiary
The beneficiary you choose on your policy stays unless you change the policy. However, in some states, a divorce automatically eliminates your ex-spouse as the policy’s beneficiary. Of course, if people want to have their ex-spouse as a beneficiary, they still can but must attach a written agreement.
If people get divorced after they have set up their beneficiaries, they should name a new beneficiary so that the death benefit is paid to someone they have chosen. Once again, because the beneficiary designation trumps what someone put into a will, it’s crucial to keep the beneficiaries up to date.
Lifelong Dependents as Beneficiaries
Many people purchase life insurance because they have someone with special needs or other lifelong dependents. So, it is logical to name them as a beneficiary to support them financially throughout their lifetime. But, doing so could make them ineligible to receive government assistance. They could be disqualified from Medicaid and Supplemental Security Income by receiving over $2,000 as an inheritance. Therefore, they can suffer financially it can be a significant loss in financial protection for them.
Of course, there is some sort of solution to this potential problem. Similarly to the minor child as beneficiaries, you can establish a special needs trust and name the trust as beneficiary. That way, your assets or death benefit will be for someone with special needs without triggering laws. If this is your situation, consult an attorney specializing in estate planning to give all the necessary information.
What About Taxes on the Policy’s Death Benefit?
Typically, with most life insurance policies, beneficiaries do not have to pay income taxes on a life insurance payout, and they would have to report the money on their income tax returns. Unfortunately, a death benefit can be subject to estate tax in some cases. For example, if the life insurance is included in your estate and your estate exceeds the estate tax exemption set by federal (or state) law.
We always recommend a whole life insurance policy as the best option. Along with other benefits of the whole life policy, you are definite that there wouldn’t be taxation.
Who Can Modify the Beneficiary?
Usually, the policyholder can change beneficiaries, but here are some exceptions:
Irrevocable beneficiary. If the life insurance policy is written with an irrevocable beneficiary than the policyholder can’t change that beneficiary without their consent.
Power of attorney. According to some state laws, a power of attorney can change your beneficiary on the policy. If that is the case with your estate, a power of attorney should be someone confidant.
Community property laws. As we mentioned, if you live in a community property state, your spouse may have rights to the death benefit and to adjust the beneficiaries.
The Ultimate Way to Support Your Family Members
If you want to have living benefits and also the opportunity to support your family when you’re gone, then the best life insurance for you is a whole life policy. A whole life insurance policy is a type of permanent insurance, meaning you will have lifelong coverage. But, another component of the whole life is the cash value.
Whole life insurance offers more comprehensive insurance than term life because it includes guaranteed death benefits and financial life insurance benefits like the opportunity to build cash value over time tax-deferred, with access to these funds during your life. Even if term life insurance costs less than whole life, with whole life, your monthly premiums remain the same. With most term life insurance policies, premiums rise substantially as the policyholder ages.
In contrast, with whole life insurance, you have a guarantee that the premiums you pay for a specified amount of life insurance coverage will never rise over your lifetime. In addition, having a whole life policy allows you to start your Infinite Banking Concept, or overfunded life insurance, and become financially independent!
Overfunded Life Insurance
Overfunded life insurance, or cash value life insurance, is a financial strategy that relies on your whole life policy. Thanks to the cash value component of whole life policy, you can access that cash anytime and use it however you want. You can use money from your policies for anything from financial obligations like rent or mortgage costs, final expenses, pension funds, and emergency expenses to tuition, family vacation, or a new car.
The policy’s cash value is the sum of the death benefit that the life insurance company make liquid to you. With overfunded life insurance, you literally have your own bank! Your bank involves a portion of premiums paid, guaranteed interest earned, and potential dividends.
Choosing and buying life insurance is a complex and responsible step in our lives. Because there are many aspects, we wanted to explain the most common rules and restrictions of naming life insurance beneficiaries. We hope this article helped you better understand this aspect of life insurance.
If you’re ready to take finance into your hand and provide a better future for you and your family, then overfunded life insurance is the best investment you can make!