Planning for your death is not a pleasant experience. Apart from choosing your heirs in your will, choosing the beneficiaries of your life insurance policy is possibly the most challenging part of planning for your passing.
However, you should never make choosing your life insurance beneficiary an afterthought. Since life insurance is intended to support those who depend on you when you pass away, you want to make sure that those people get the help they need. Fortunately, the payout to each beneficiary is tax-free.
What is a life insurance beneficiary?
A life insurance beneficiary is a person or entity who receives the death benefit in the case that the policyholder, the person who purchased the life insurance, dies. If you don’t name a beneficiary for your life insurance policy, or your beneficiaries predecease you, the insurance company will transfer your life insurance payout to your estate. In that case, your estate will need to pay the relevant taxes on this sum.
Who can be a beneficiary?
When you choose a life insurance beneficiary, your selection is not limited to your inner circle. While you could choose your spouse, children, parents, siblings, or other relatives, you can also choose friends or business partners. Furthermore, you can make a business, charity, trust, or estate into a beneficiary if you so wish.
That said, some people can’t be beneficiaries. For instance, minors will not receive a payout from your policy until they turn 18. In the case you want to name a minor as one of your beneficiaries, you must set up a trust in their name. Therefore, you should select someone you trust to be the trustee. Moreover, you may not name your pet as a beneficiary because pets are considered property.
Primary and secondary beneficiaries
When you’re planning your life insurance policy, you should know that you can create two tiers of beneficiaries. Between primary and secondary beneficiaries, you can choose to split their benefits however you wish.
Primary Beneficiaries
The primary beneficiary or beneficiaries are the entity or people that your life insurance policy pays out to in the event of your death. You can assign each beneficiary an equal percentage of the payout, or you can customize their portions however you wish.
Secondary Beneficiaries
Also known as contingent beneficiaries, it is useful to name secondary beneficiaries just in case your primary beneficiaries predecease you. Once again, you can decide to apportion the benefits to this tier however you like. Although it might not seem necessary, naming a contingent beneficiary is a good backup plan. After all, you probably prefer a deserving entity, such as a charity, to receive the full amount of the payout rather than losing some of it to taxes.
Revocable and Irrevocable Beneficiaries
The difference between these two types of beneficiaries relates to the ability you have as a policyholder to revoke the right of a beneficiary to your life insurance payout.
Revocable Beneficiaries
Revocable beneficiaries do not have any guaranteed rights. As the policyholder, you may revoke their rights to your death benefit at any time.
Irrevocable Beneficiaries
It is quite uncommon to make an individual or entity an irrevocable beneficiary. The only way that you can deny an irrevocable beneficiary the claim to your death benefit is if you have their consent. The most useful application of this rule is when you make your child an irrevocable beneficiary to ensure that they receive the life insurance payout.
Who should be my beneficiary if I’m single?
Even if you don’t have a partner, you have many choices when you decide on a beneficiary. If you’re single, you could name your parents, siblings, friends, or children as beneficiaries. Otherwise, you could also choose a business or a charity.
How do you split life insurance beneficiaries?
When you name multiple beneficiaries, you can always split the percentage each beneficiary receives however you like. That said, there are two common methods for dividing up the death benefit among your beneficiaries. If you don’t specify an allotment, then the benefits will automatically split per capita – equally between the beneficiaries.
Another common way to divide the benefits is per stirpes – in which you assign a certain unequal portion to each generation but divide the allotment equally between each member of that generation.
If one of your beneficiaries dies, you should review and potentially revise the allocation of your life insurance benefits.
8 tips for choosing a life insurance beneficiary
Here are some best practices for when you’re choosing a life insurance beneficiary.
1. Know the rules
As you should know, minors are not entitled to receive life insurance benefits directly. Rather, you should set up a trust so that the trustee can send them payments from the life insurance benefit as soon as possible after your death.
Furthermore, various state-specific laws could affect your ability to name beneficiaries. In some states, your spouse will receive life insurance payouts regardless of whether you name them. In other cases, the terms of your divorce might require you to pay alimony or child support.
You should also understand that if you don’t clearly choose beneficiaries by name and apportion the benefits correctly, you could cause a lot of trouble down the line for your heirs. For instance, they might need to decide how to divide it themselves or pay extra taxes.
2. Consider who needs it the most
Life insurance essentially secures your financial position in the case that you die and can’t provide for your dependents. Therefore, you should probably give your life insurance benefits to those who depend on you. Forbes found that after the passing of a policyholder, 37% of beneficiaries needed the life insurance payout to pay for funeral costs, 32% needed the benefits to maintain their standard of living and 17% needed it to pay their debts. Evidently, your passing could cause your family or other dependents significant financial distress.
3. Update your beneficiary choice
Every time you encounter a major life event such as a marriage, death, or birth, you should update your choice of beneficiaries. Ensure that each part of the policy is worded correctly. As a policyholder, you can change the document as long as you’re still alive.
Note that in the case of divorce, some states have special stipulations to ensure that your life insurance payout goes to alimony or child support payments that your children or spouse depended on before.
4. Doesn’t need to be a person
As we mentioned earlier, you could name almost any commercial or charitable entity as a beneficiary. If you are in a key leadership role at your business, they might benefit from your policy payout in case you die since you might be hard to replace.
5. Read the language of the life insurance policy
The devil is in the details. If you don’t name your beneficiaries directly, there might be a legal mishap. For instance, if you simply name your “children” as beneficiaries, your adopted children will not receive a payout.
6. Your will must match your life insurance
When you update your will, remember to update your life insurance at the same time. The payouts to your heirs and life insurance beneficiaries don’t need to be identical, but it’s prudent to consider changes to both at the same time.
7. Choose multiple beneficiaries
If you’re unable to decide who to give benefits to, you can always create multiple classes of primary and secondary beneficiaries. Provided you can understand the conditions, it could be a great way to spread the wealth amongst your family or even charities in the case of your demise.
8. Communicate your wishes
From time to time, there can be misunderstandings regarding your life insurance policy after your death. Ensure that your beneficiaries and even heirs understand your intentions when you design a payout system for your life insurance policy. That way, you can minimize the conflict in the case of irregularities or confusion.