What is a beneficiary? Perhaps the clearest definition comes from the Insurance Information Institute which states: “A beneficiary is a person or entity that you name in a life insurance policy to receive the death benefit.” In other words, a beneficiary is a person or entity who will receive the life insurance proceeds upon your death.
Also included in the definition of beneficiaries are those who receive distributions from wills, trusts, annuities or retirement accounts. But, we want to focus primarily on life insurance here since 52% of Americans have such a policy. Most importantly, naming a beneficiary is a key part of a life insurance policy because it can protect the financial future of your loved ones.
The next question you are probably asking yourself is who can be named as a beneficiary? The short answer? Anybody.
Preferably, however, the beneficiaries are often;
- Close family members, such as your spouse, children or grandchildren
- Other family members like your siblings
- Your estate
- A trustee or trust that you have established
- Your business
- Guardians of your children if they are minors
- Charity or non-profit
In general, you should ask yourself if your loved ones will suffer financial hardship if you die suddenly during the designation of beneficiaries. In addition, you can designate several people to be your beneficiaries. In the thirds, say, between a surviving spouse and two children.
Overall, selecting beneficiaries and updating those choices is arguably the most important part of owning a life insurance policy. And, to make sure there aren’t any unintended or adverse consequences, here are ten beneficiary designation mistakes to avoid while you’re alive. I mean once you’re gone you can’t come back and rectify those mistakes.
1. Do not name a beneficiary.
Not having a named beneficiary on your life insurance policy is possibly the most serious and glaring mistake you can make. However, just naming your spouse or child as the beneficiary may not always be enough. What happens if your spouse or named beneficiary dies before you do? Or if you and your spouse died together in a tragic event like a car accident?
Depending on your beneficiary designation, the insurance company may pay your estate the proceeds of death if you have not named a beneficiary or if it is no longer alive at the time of your death. Suffice to say that this could cause other problems to unravel for your estate.
2. Failure to list contingent beneficiaries.
You must designate a primary beneficiary and a contingent beneficiary in your life insurance policy, advises III. If your primary beneficiary is found after your death, they will receive death benefits. If the primary beneficiary cannot be found, death benefits are paid to the subsidiary beneficiaries. The death benefit will be paid to your estate if the primary or secondary beneficiary cannot be found.
“If you are married, your spouse is normally your primary beneficiary and your child or children are subordinate,” says Ken Nuss for Kiplinger. “Contingent beneficiaries will receive the proceeds upon your death if your primary beneficiary dies before or at the same time as you. “
“Although you need to notify the insurer of the death of a primary beneficiary, even if you don’t, the proceeds will automatically go to your secondary beneficiaries,” Nuss adds.
3. Not understanding the difference between revocable and irrevocable designations.
Revocable beneficiaries are common in life insurance policies. The owner of the life insurance contract remains in control of this type of life insurance designation, says Fidelity Life.
If you have a policy, you can change the revocable beneficiaries or change the percentage of the payout that each beneficiary receives. Changing beneficiaries is usually as easy as filling out a form, and your beneficiaries have no say in the matter. This approach allows you to change beneficiaries based on your changing circumstances and priorities during the policy.
It can be a little more complicated to manage life insurance policies with irrevocable beneficiaries. Unless the irrevocable beneficiary approves, you are not allowed to change the beneficiary. If you want to change the beneficiaries, the current beneficiary and any potential beneficiaries must consent.
In short, irrevocable beneficiaries are basically guaranteed to receive the life insurance proceeds, unless they agree to be removed from the policy. You should be 100% sure of your irrevocable beneficiaries if you add them to your life insurance policy. As such, her children are often named as irrevocable beneficiaries in life insurance policies.
4. Lack of details.
If you are part of a blended family, simply registering “my children” as your beneficiaries could be problematic. In fact, the term “children” is not recognized in most states when it comes to stepchildren. It is also possible that a distant family member will show up and try to take part, maybe even all of your estate even if it is not what you planned.
Finally, what happens if one of your children dies? Unless you provide detailed instructions, the child’s share will go to your other children and not to that child’s heirs. In order to avoid disinheriting some of your children or grandchildren, unless that is your plan, you need to be as specific as possible.
5. Designate a minor child as beneficiary.
When one or both parents die unexpectedly, life insurance will provide for their children’s needs. At the same time, it may not always be wise to designate minors as beneficiaries.
Minors cannot receive life insurance benefits directly from life insurance companies. The court may appoint a guardian to manage the life insurance proceeds of your minor children if you purchase it without creating a trust or making other legal arrangements. In this case, it is best to create a trust and designate the trust as the beneficiary of the policy. It is also possible to designate an adult custodian for policy proceeds under the Uniform Juvenile Transfers Act.
6. Name a beneficiary who has special needs.
An additional problem arises when direct beneficiaries are referred to as people with special needs. For example, people with special needs may receive government benefits based on their income, such as Supplemental Security Income, Medicaid, or Housing Assistance. As such, they may be excluded from receiving government assistance if they are designated as direct beneficiaries, as this would increase their income.
“Fortunately, you can still purchase life insurance on your life,” says Rubin Law. “Establish a Third Party Special Needs (SNT) trust that benefits your child and name SNT as the beneficiary of the policy. “
In the event of death, the lump sum will be paid to the trust. For the purposes of government benefits, money held by SNTs is generally not counted as income. In fact, SNT may be able to pay certain expenses directly without affecting eligibility for benefits.
7. Don’t update your policy.
“It’s more common than you might think to find someone on a former spouse’s life insurance policy beneficiary list,” writes Mary Randolph, JD for Nolo. “And after the insured dies, there is nothing nobody can do about it.”
“Update your beneficiary designations (pensions, retirement accounts and bank accounts payable on death as well as insurance policies) whenever there is a big life event: you get married, divorce or have a child or a grandchild joins the family, “advises Randolph.
8. Death benefits will go to your estate.
There are several problems when the proceeds of your life insurance are paid to your estate. First, the product may be subject to probate, which could delay payment by your heirs of the policy proceeds. Second, since your life insurance is part of your probate estate, your creditors have the right to claim the proceeds.
In addition, your creditors may be able to satisfy their claims on these products before your heirs can receive their share. Designating your primary, secondary and ultimate beneficiaries may prevent the proceeds from being distributed to your estate.
9. You don’t understand the difference between per strain or per inhabitant?
Many people name more than one beneficiary to receive life insurance proceeds. But it can get tricky if one of the beneficiaries dies before you do.
Would you like the deceased beneficiary’s share to be included in the surviving beneficiaries’ share? Or should it be passed on to their children? Per capita versus per strain is the distinction.
Although it is not necessary to use legal terms on the insurance beneficiary designation form to indicate what happens if a beneficiary dies before you do. However, it is important to indicate how you want the share to be transferred if a beneficiary dies before you do.
By strain (by branch) means that the next generation inherits from a deceased beneficiary. Per capita (per capita), means that each surviving beneficiary receives an equal share of what the deceased beneficiary would have received.
10. Be taxed with a different policyowner, named insured or beneficiary.
In general, life insurance death benefits are tax free. The death benefit may be taxable if you have a life insurance policy owned by one person, insured by another and benefiting from a third.
By designating your adult child as the beneficiary of your spouse’s life insurance policy, you are effectively giving your child the benefits of the policy. In this situation, you may be subject to federal tax if the total amount exceeds the limits. A financial advisor can assist you in structuring your life insurance contract in order to possibly avoid a tax situation in such circumstances.