If you’re buying life insurance, you’re doing so because you have a goal for the payout. Maybe you want to provide funds for your family to pay bills if you’re gone, or to pay for children’s college education.
Many life insurance buyers become motivated to buy a policy because of a life event. For 20% it’s getting married, according to a survey by Erie Insurance that was conducted in July 2020. Another 20% said they were motivated by having a child, and 14% said they took action after buying a home.
Your reasons for buying life insurance will translate into naming a beneficiary: Who should receive the funds in order to meet your goal for the payout?
Think of it as one of the notable times in your life when you—and only you—get to decide what is the right choice. After all, this is a personal decision and you can do as you please, instead of having to please someone else.
That’s because life insurance is a legal contract that can seldom be challenged, except under very special circumstances, and is even less likely to be overturned in court than a will. You may offend someone—or several people—with your choice of beneficiary, but what can they do about it? Truth is, unless you tell them ahead of time, they probably won’t find out they’re not your life insurance beneficiaries until after you’re dead.
And maybe not even then. “State and federal privacy laws limit the persons to whom an insurer can provide information relating to a life insurance policy,” says Amanda Wallace, the head of insurance operations at MassMutual. And, if the beneficiaries in your will don’t match the beneficiaries in your life insurance policy, she promises that “your life insurance beneficiary designation will always prevail.”
Most people (59%) name their spouse as their life insurance beneficiary, and 38% of people name their children, according to the survey by Erie Insurance. Some even say they’ve named a dog or cat as beneficiary, even though pets can’t directly get life insurance money.
The Needy or the Greedy?
Not only can you exclude your ne’er-do-well son and/or never-wants-to-visit daughter without precipitating a brawl at the executor’s office when the will is read, but you can also keep a greedy uncle from getting his fingers on a payout.
While the rest of what you leave can be subject to state and federal taxes, the payout from a life insurance policy is tax-free. Only any interest collected on the money afterwards is subject to taxation. “It’s Uncle Sam,” says Nicholas Mancuso, who runs the advanced planning team at online insurance marketplace Policygenius.
So, think of naming a life insurance beneficiary as a way to give your money to who you want, or provide for what you want: a favorite charity, a pet, your own funeral.
In most instances, policyholders focus on the ones who’ll most need the payment if they die. That is the person or persons most reliant on your income or savings.
“Your main purpose is to make sure your family is well-provided for,” says Ed McGill, a partner in the firm McGill Junge Wealth Management.
What Does Your Life Insurance Protect?
The main reasons for buying life insurance are to pay for funeral expenses (37% of buyers) and leave an inheritance (37%), according to the Erie Insurance survey. Other top reasons are to provide funds so loved ones can continue their standard of living (32%), pay debt (17%) and make mortgage payments (10%).
Life insurance policies can also be used to keep businesses, especially family businesses, afloat, in which case a company could be named as beneficiary because the so-called “key man” or rainmaker is no longer there.
The life insurance amount you can afford, and nature of the policy, could affect who you’re likely to name. A term life insurance policy, with a time frame of 30 years, might suffice for seeing your children through college, or maintaining a business. A small burial insurance policy would pay for your funeral. And a universal life insurance policy may be an effective way for those with assets to pass them on to their heirs.
Whatever the need, it is important to decide on the best beneficiary. But in certain instances, no one does.
“We find that a lot of group life clients do not choose a beneficiary,” says Sammy Rubin, CEO of YuLife, which provides ways for businesses to offer employee incentives for healthy lifestyles. And that’s because the insurer tends to deal with the business, as opposed to an employee who may have left the policy in a pile with his other company paperwork.
By not choosing a beneficiary, you can create a legal nightmare for your heirs, as well as reducing the payment they could ultimately receive. The proceeds of the policy without a named beneficiary—large or small—become part of the policyholder’s estate and are then governed by the will and the way in which the executor doles it out. No will? Even worse. The life insurance payout is now the province of a probate court.
Branches on the Tree of Life.
There are a multitude of options when choosing beneficiaries. These range from one to several beneficiaries, and different ways to divvy up the money they’ll get:
One way is per capita, or by “head,” in which case the amount is split equally between all beneficiaries, often the children.
Another is per stirpes, or by “branches.” This means that if a child predeceases the policyholder then his or her children—the branches—receive what would otherwise be shared among the living children. Per stirpes is a valuable tool for protecting grandchildren, particularly if they’ve lost a parent.
When it comes to protecting grandchildren, or even that pair of beagles who were your best friends during your later years, nothing works as well as setting up a trust for all, or at least some, of the money in your policy.
“Name the trust as the recipient of the life insurance proceeds,” suggests Vice President Andy Bucklee of Lincoln Financial Group. With a trust, the life insurance proceeds automatically go into the trust and not the estate.
But if you decide to take this route, it’s critical to find good trustees. A policyholder might want to ensure that a young beneficiary doesn’t squander his inheritance on a Lamborghini and forget about college. The policyholder may also want to guarantee that a favorite charity receives the money needed to help end world hunger, or just prevent the cats from being taken to the pound.
A trust is a way to accomplish this. In a sense it keeps your hand on the tiller of your financial ship even after you’re gone. An attorney can help you make a trust as part of an estate plan.
Life Insurance Is a Living Document.
While a life insurance policy is a contract, it’s important to remember that it’s not set in stone. It’s a living document—at least while the policyholder is alive—and its beneficiaries can be changed at any time with either a request form or online, says MassMutual’s Wallace. It’s a good idea to look it over at least once a year.
Your likes and dislikes can lead to change. For example, the child that steps up to the plate during an illness or injury while another sits the bench. Divorce and remarriage can also lead to change, particularly if there are new children to consider.
There are two scenarios when naming a beneficiary.
One is revocable, in which case the policyholder can change who they want at any time.
The other is irrevocable, and in this instance once named, someone can’t be removed from the policy. This might occur with a spouse who may worry about being kicked to the curb in a divorce/remarriage situation.
And speaking of divorce: A settlement might include a stipulation that one or both spouses maintain life insurance, especially if they’re going to owe alimony or child support.
Since your life can constantly change, and people can come and go, insurers recommend naming contingent beneficiaries. These are people or entities like charities that would receive the money if the primary beneficiary has died. This is something that should always be considered, especially if the spouse is a primary beneficiary, and the couple is growing old together.
Yes, the beneficiary is your choice, but it’s also an important choice, and it should never be made lightly. “It makes a statement,” says Wallace, “and it’s part of your legacy.”