Choosing a beneficiary (or multiple) for your life insurance policy is one of the most important parts of the application and purchasing process. After all, the reason you buy life insurance in the first place is to protect your family financially.
While naming a beneficiary is pretty straightforward, it’s still important to ensure it’s done correctly. (Because anything worth doing is worth doing right.)
Incorrect names or contact information and even naming children as beneficiaries can cause unnecessary stress and complications when trying to file a claim and receive the policy payout.
A correctly listed, relevant beneficiary helps ensure the payout for the life insurance policy (called a death benefit) is delivered promptly to the correct person (kind of a big deal.)
Here’s how you can avoid any missteps when naming a beneficiary for your life insurance policy.
Who Should You Name as a Beneficiary?
Starting with the basics, a beneficiary is a person who will receive the payout for your life insurance policy. You can name pretty much anyone as a beneficiary: your spouse, child, parents, siblings, BFFs, a trust. The list goes on. But, most people name their spouse as the primary beneficiary.
You can name more than one beneficiary if you’d like. If you choose to do so, you’ll need to designate the amount or percentage that goes to each person. For example, each of your siblings gets 50%. You can also name a contingent (sometimes referred to as a secondary or alternate) beneficiary who would be second in line to receive the payout if the primary beneficiary cannot accept it.
Be prepared to submit the following when naming your beneficiary(ies) – the more specific you are, the better:
- Full name
- Date of birth
- Relationship to Insured
- Phone number
- Amount or percentage they should receive
- Social Security Number (optional)
Why Electing A Contingent Beneficiary Makes Sense
When choosing a beneficiary, consider naming both a primary and contingent beneficiary. For example, if you name your spouse as a primary beneficiary and both of you were to die at the same time, who would you want to receive the death benefit? For many, it’s a sibling, parent or the person who would become the primary guardian of your children.
Whoever that person may be, it’s important to plan ahead and name him or her as the contingent beneficiary. This helps ensure the appropriate person receives the payout versus it being left to your estate to determine.
The other option is to name a trust as a contingent beneficiary, which will have specific instructions for who the money should go to and how it should be utilized.
Naming a Trust as a Beneficiary
When most people think of a trust, they think of the uber wealthy. But, having a trust isn’t only for the 1%. Many young families can benefit from establishing a trust as a beneficiary of their life insurance instead of simply naming their children or another loved one.
Most parents who have purchased life insurance to protect their families have named a spouse as a sole beneficiary. But, what happens if the spouse passes away, too? A trust could protect your family if both parents were to die at the same time and leave minor children behind. Additionally, a life insurance company will not give a check to a minor.
“Parents should consider establishing a trust to act as the beneficiary if they have young children,” says John Goralka, founder of The Goralka Law Firm in Sacramento, California. “Without the trust, a minor beneficiary may trigger the requirement for a formal guardianship through the Courts to oversee the funds until the child attains the age of 18.”
Court supervision can add unnecessary costs in the form of legal fees and court costs for your estate, which reduces the overall benefits to the minor beneficiary. Additionally, in the absence of a trust, a professional trustee named by the court may or may not release any funds before age 18 to help the child’s guardian or for any other reason.
Establishing a trust can help parents direct how much money and at what age their children receive it. It also provides a trusted family member, friend, or a professional trustee with the ability to provide the needed oversight, guidance, and control to ensure that the funds are used wisely to the long-term benefit of your children.
“The trustee, typically a family member, can distribute the funds to the children per the trust’s specifications, says Chris Huntley, author of ‘Life Insurance Beneficiaries and Minor Aged Children.’ “For example, the trust may allow for annual distributions to be made to the new guardian/s to help raise and care for the child, or allow money for his/her first car or tuition for college.”
If considering a trust, consult with a tax advisor to ensure that you aren’t accidentally setting up a situation where proceeds from a life insurance policy will be regarded as a gift. Most of the time, life insurance proceeds aren’t taxable, but if the beneficiary, insured, and policy owner are three different people, you may need to reconsider the structure of your life insurance policy.
When naming a trust as a beneficiary, you must include:
- Name of Trust
- Tax ID Number (SSN/ EIN)
- Date of Trust
- Type of Trust.
Common Mistakes to Avoid
Not telling someone they are the beneficiary – While this might seem like a surprising scenario, it’s pretty common. No one likes to talk about or even think about death. Make sure your beneficiary knows you purchased a policy, how much it’s for and where they can find the details of the contract in the event of your death.
Naming a minor as beneficiary – Legally a child under 18, and in some states 21, can’t access a life insurance death benefit. If you haven’t named a legal guardian or set up a trust to manage the money, the court will handle distributing the death benefit for you, which can get very complicated. There are a few ways to navigate this tricky situation. The easiest solution is to set up a UTMA custodianship with the life insurance company. This ensures that the child receives the full death benefit for the policy. You’ll also need to name a custodian who will be responsible for the assets until your child is no longer deemed a minor by the state (typically between ages 18 and 21). Another option is to set up a trust fund that can receive the life insurance proceeds. If you decide to go the trust route, make sure it specifies how the money should be delivered – installments, a lump sum when the child turns a particular age, etc.
Forgetting to update your beneficiaries – Just like you should review your policy needs after major life events, you should also revisit your policy beneficiaries and the listed information periodically. Common errors include: incorrect contact information, listing a former spouse, or listing a legal guardian when a child is no longer a minor. The last thing a beneficiary should have to worry about when losing a loved one is how to collect the proceeds, which they may need immediately to cover timely expenses.
Not considering government assistance – If your beneficiary receives government assistance of any kind, you’ll want to ensure that receipt of a death benefit from your life insurance policy won’t disqualify them from further assistance. For example, if you have a special needs child and name him or her as your beneficiary, they may no longer be eligible for government assistance because of the sum of the “gift.” This is another instance where you’d want to look into naming their legal guardian as the beneficiary or establishing a special needs trust fund.
Assuming a will covers all updates – Your life insurance policy is a legal contract, which means the terms listed on it are the ones that go into effect if you die. Your will does not control or trump this contract. For example, if your will lists the beneficiary as your husband and the life insurance policy has your ex-husband listed as the beneficiary, the death benefit will be paid to your ex. Best to avoid that potentially uncomfortable situation altogether by consistently monitoring your beneficiary designations.
(Accidentally) Making your death benefit taxable – Here is where things can get pretty tricky. Typically, a life insurance death benefit is received free from federal income tax. However, there are situations where the payout can is considered an income taxable event or a “gift” that could be subject to federal and state gift taxes. This can occur if a third-party beneficiary is involved (someone who isn’t the owner or the insured) then the death benefit is deemed a gift and may be subject to gift tax. For example, if you are the owner of a policy that’s covering your spouse and then name your child as a beneficiary. To avoid this, the insured and the owner should be the same person.
Beneficiaries: The Heart and Soul of Life Insurance
The purpose of purchasing a life insurance policy is to provide financial security for your loved ones. To do that, you must name someone as the beneficiary.
It’s important not to treat naming a beneficiary like a checkbox in your life insurance application process. Be thoughtful about who you are naming as a beneficiary, the information you provide on them and periodically check in to ensure accuracy. Due diligence early on and throughout the life of your policy will save your loved ones unnecessary stress and potentially a lot of money if anything were to happen to you.
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This discussion is intended for general education only and is not legal or tax advice. Haven Life doesn’t recommend any products or services discussed.