Naming a life insurance beneficiary should be an easy and uncomplicated process. While it can be straightforward in many cases, there are a number of potential legal, financial, and tax-related problems that can occur if you don’t name your beneficiaries properly. Therefore, it’s important to find out how you can avoid making simple but potentially costly mistakes.
Life insurance beneficiaries are frequently spouses and children of the insured. However, we live in a dynamic world in which the “typical” family may not be so typical. Consider these statistics about U.S. families:
How do you designate a life insurance beneficiary legally? There are two basic types of life insurance beneficiaries:
Primary beneficiary: The primary beneficiary is the person (or persons) who will receive the proceeds of the life insurance policy when the insured person dies. However, the primary beneficiary will not receive any proceeds if he or she dies before the death of the named insured.
Contingent beneficiary: This is also known as the secondary beneficiary. The contingent beneficiary will not receive any of the life insurance proceeds if the primary beneficiary is still alive when the insured person dies. The contingent beneficiary is only entitled to receive proceeds if the primary beneficiary dies before the named insured.
Many professionals in the industry feel that the best or safest approach is to name a primary beneficiary and a contingent beneficiary on a life insurance policy.
There are two classes of beneficiaries known as revocable and irrevocable beneficiaries.
Revocable beneficiaries: The owner of the life insurance policy has the right to change the beneficiary designation at any time without the consent of the previously named beneficiary.
Irrevocable beneficiaries: The owner of the life insurance policy cannot change the designation of the beneficiary without the consent of the original beneficiary.
Which is the better choice? Most experts consider that the simplest way is to go is with a revocable beneficiary option. There are a number of potentially complicated legal issues that can occur if you opt to go with an irrevocable beneficiary.
How do you choose who should be your life insurance beneficiary? You should consider:
If you want to name more than one life insurance beneficiary, there are two approaches you can take:
Per stirpes: You can designate your beneficiaries by “branches of the family or lineage.” This means that the life insurance proceeds would be passed down to be divided equally among the beneficiaries and/or the surviving children of the beneficiaries.
Example: You, as the insured, designated your son (John) and daughter (Jane) as beneficiaries. Your son John dies before you do. If you were to pass away next, then Jane would receive 50 percent of the proceeds and the remaining 50 percent would then be apportioned equally to all of John’s surviving children.
Per capita: Simply put, the proceeds are divided equally among all the beneficiary survivors of the lineage line.
Example: Using the above scenario, suppose John had four children and Jane had no children when you, as the insured, passed away. This means that the proceeds would be divided equally between John’s four children and Jane. Since there are a total of five beneficiary survivors, each beneficiary would get one-fifth of the life insurance proceeds.
If you have multiple beneficiaries, it is best to designate that proceeds will be distributed as a percentage rather than a dollar amount.
Why? You might buy a $100,000 universal life insurance policy and apportion $50,000 to your two children as beneficiaries. But, when you pass away, the policy could be worth $120,000, and the insurance company will have no instructions on how to legally divide up the remaining $20,000. An unfortunate and avoidable legal battle could ensue for the remaining portion of your policy.
If your beneficiary dies before you do, you must rename the beneficiary on the policy as soon as possible. How do you do this? All you have to do is contact the life insurance company and request a “change of beneficiary” form.
If both the insured and beneficiary die at the same time, then the proceeds would go to the insured’s estate.
The “Dos and Don’ts” of Naming a Beneficiary
Here are some things you should do and some things you must avoid when naming a beneficiary:
Naming a beneficiary requires some thought. If you don’t put some thought into how you name your beneficiaries, your family and estate may face legal or tax complications. Always keep your beneficiary information current on all your life insurance policies.