Who should you list as a beneficiary when you buy a life insurance policy?

This is an important question and the following should help guide you in making this very key decision.

What is a Life Insurance Beneficiary?

When you buy a life insurance policy, you will be asked to name a beneficiary. A beneficiary is one who will receive the death benefits and/or the cash value accumulation of the policy (only applicable for permanent insurance policies such as whole life, universal life and variable life insurance policies), upon the death of the insured person.

You have two options when choosing a beneficiary. Your first option in choosing a beneficiary can be one or more persons which could be your spouse, your eldest child, spouse and children, some other relative or any other person you designate. Your second option is to choose an entity such as your estate, a trust, or a charitable organization.

What’s the Difference between Choosing a Person or an Entity as Beneficiary?

There are differences in how the benefits will be treated by choosing a person over an entity.

Choosing a Person as Beneficiary

When you select a person as a beneficiary, all the proceeds from a life insurance policy are paid directly to that individual or apportioned to the person’s named (if more than one). The benefits paid are given as a lump sum and are not generally taxable.  A person who is the beneficiary can also spend the funds in any manner they choose.

You do not have to draw up a will to ensure they receive your life insurance benefits.  This is one nice feature about life insurance.  You get to quickly and simply name who gets the money without the need for lawyers and lawyer fees.

Additionally, you also have the option of changing the beneficiary.  However, there are two types of beneficiary types which are either revocable or irrevocable beneficiaries.  A revocable beneficiary means you can change the named beneficiary anytime during the life of the insurance policy.  An irrevocable beneficiary means that both the owner of the policy and the beneficiary must agree to make any changes to the policy beneficiary.

Choosing an Entity as a Beneficiary

Some life insurance owners may decide on an entity to act as their beneficiary.  The most common choices include the estate or a named trust, such as the family trust with a lawyer acting as trustee.

A will is normally required and recommended for this situation.  If you do not have a will, it is possible a state-appointed trustee might assume responsibility in determining how the proceeds will be doled out and to whom.  If you do draw up a will, it is also highly recommended that you keep it current and make changes as they occur.

The reasons why some people opt to use an entity as a beneficiary normally entail the following reasons:

• To set up a trust if you have young children, or to ensure the funds are paid in a specific manner, or to be paid out when they reach a certain age.
• To ensure that the life insurance proceeds are designated to some other party or parties.  This could be some combination where a family member, close friend and/or one or more charitable organizations are designated to receive funds which should be clearly specified in the terms of your will.
• You may also need to name an estate as beneficiary if you have no spouse or children.

The legal aspect of how funds are distributed is also somewhat different when choosing an entity as a beneficiary. This includes:

• All insurance proceeds are paid to the estate.  This in turn becomes part and parcel of the probate process.
• How the money is paid will be determined by the terms you have designated in your will.
• These insurance proceeds must also be available to creditors if there are any outstanding debts.
• As the insurance proceeds may be distributed through probate, there are usually lawyer probate fees involved.  The amount may vary from state to state, but the maximum is usually in the neighborhood of 5% of the total amount of the estate.
• If you wish to change your beneficiary in this instance, you will have to use your lawyer and will need to change the terms of the will.

Primary Beneficiaries vs. Contingent Beneficiaries

The difference here is quite clear.  You primary beneficiary is the person (or people) who is intended to receive the death benefit upon the insured’s death.  If things don’t go as planned, though, and the primary beneficiary(ies) predeceases the insured, or dies at the same time as the insured, for example in the case where a husband and wife are killed together in an accident, then the contingent beneficiary(ies), also known as secondary beneficiary, receives the funds.

One key point to make here is that if two or more primary beneficiaries are selected, and one or more of them is dead upon the passing of the insured person, the money will be distributed to the remaining primary beneficiaries, rather than any of the funds going to the secondary beneficiaries.

Some Key Points to Remember

It is vital that you make changes if your circumstances change.  This could especially be important in a divorce situation or if your named beneficiary dies before you do.  It is very important that you don’t procrastinate making beneficiary changes.

If you name more than one beneficiary, make sure they are individuals who are compatible because horrendous legal battles have broken out between family members who were named as beneficiaries.

Also, never buy an insurance policy as a third person, or what might be described as a 3 way policy.  What I mean is that you should never buy a policy where you become the owner of a policy but have bought the policy for another person such as your daughter, and a third individual is named as the beneficiary, such as her husband.  In this instance, it is very likely that the beneficiary will be considered as receiving a gift from the purchaser of the policy by the tax people and the proceeds will be taxed.

Give some careful thought to who you want to name as a beneficiary, and consider the pros and cons from the above information to make an informed choice.  As always, call us with any questions or for a life insurance quote at 877-996-9383.