How to choose a Life Insurance Beneficiary? Allocation Rules and More.

There are two types of life insurance beneficiaries, a primary beneficiary, and a contingent beneficiary. Each designation determines how the death benefit is paid to all beneficiaries.

Life insurance is purchased for many reasons. But there is typically one element that is similar in all life insurance purchases – the future financial security of the life insurance beneficiary. That’s why it is important to know how to choose beneficiaries for life insurance, both primary vs contingent.

What is a Life Insurance Beneficiary?

A life insurance beneficiary is an individual or entity (such as a trust or a charity) that you have named in your policy to receive the death benefit proceeds. Deciding who receives your proceeds, as well as how much each will receive, is one of the most important decisions in the life insurance buying process.

Some of the most common types of beneficiaries may include:

  • Individuals
  • Charitable Organizations
  • Trusts
  • Businesses

Primary Vs. Contingent Beneficiary

There are different types of beneficiary designations that you can make on your life insurance coverage. These include primary and contingent. The primary beneficiary (or beneficiaries, if you have more than one) stands to receive the proceeds first.

If, however, your primary beneficiary passes away while the policy is still in force, the contingent beneficiary (or beneficiaries) are essentially the next in line to receive the death benefit proceeds.

There is even a third type. This is known as a tertiary beneficiary. The tertiary is essentially the “back up” if both your primary and contingent beneficiaries should pass away before you do.

Because the unexpected can, and often does, occur, it is important that you name a primary and contingent beneficiary on your life insurance coverage. Also, because your life changes over time, it is recommended that you regularly review the beneficiary(ies) and make any revisions if necessary.

Naming a Minor as a Beneficiary

Most people will have to decide if they should leave their spouse or child as the primary beneficiary. If you have young children, it is likely that you need life insurance. However, if your children (or other named beneficiaries) are still minors (which, depending on your state, is age 18 or 21), the life insurance company will not pay out the policy proceeds directly to them.

In this case, you should also designate a guardian for your child (or children) who can administer the funds. Otherwise, it is possible that if there is no guardian, the probate court will choose one at the time of your passing…and it won’t likely be an individual that you would have picked. Another option is for you to arrange for the life insurance proceeds to go into a trust until your child (or children) becomes an adult.

Naming a Trust as a Beneficiary – Revocable vs Irrevocable

Life insurance beneficiaries do not necessarily have to be people. In fact, there are many different entities that could be named as the primary or contingent beneficiaries on a life insurance policy. This includes trusts.

When you name a trust as your life insurance beneficiary, the funds will remain there and can only be used for the specific purpose(s) that you designated when you set up the trust. There are both revocable and irrevocable trusts.

With a revocable trust, the proceeds from your life insurance policy may be included in your overall estate value for estate tax purposes. You will also be able to make changes to the beneficiary designation if you are the policy owner.

If, however, the policy is included in an irrevocable trust, the amount of the life insurance proceeds will not be considered in the total valuation of your estate. You may also have to receive the consent of the current beneficiary in order to make changes.

Beneficiary Allocation Rules and Process

If you have more than one life insurance beneficiary, you can allocate how much each person or entity will receive. These are known as beneficiary allocation rules. For instance, if you have two children, you could state that each will receive 50% of the total amount.

When allocating life insurance proceeds, it is important to ensure that you do not unintentionally disinherit someone. As an example, if you name each of your children specifically – such as 50% to John and 50% to Mary – you run the risk of leaving someone out if you have another child in the future.

With that in mind, it is oftentimes best to state your life insurance beneficiary allocation as, “The proceeds of this policy are to be allocated equally among all of my children.”

How to Change a Life Insurance Beneficiary

If you are the owner of your life insurance policy, you have the right to change the beneficiary, provided that the beneficiary class is revocable. Here, for instance, you can make beneficiary changes at any time without the current beneficiary’s consent.

If, however, the beneficiary is irrevocable, then the owner of the policy will not be allowed to change the beneficiary unless they first obtain the consent of the original beneficiary or beneficiaries.

Do Beneficiaries Pay Taxes on the Proceeds?

Life insurance proceeds are typically received as an income tax-free lump sum to the beneficiary. This means that survivors can make use of the total amount of the death benefit for their financial needs such as replacing income, paying off debt (possibly even eliminating the balance of a home mortgage), or other requirements.

In addition to receiving life insurance proceeds as a lump sum, there are other options. For example, the beneficiary may opt to have the insurance company retain the funds and pay them out over a period of time. In this case, the funds may earn interest, and any interest that is paid out to the beneficiary will be subject to taxation.

Are Your Beneficiaries Up to Date?

Purchasing life insurance isn’t a “set it and forget it” task. Neither is naming your policy’s beneficiary. Over time, your life changes, and so do the potential financial needs of your loved ones.

In addition, various people will come in and out of your life. So, it is important to make sure that you not only review your life insurance coverage on a regular basis, but that you also ensure that those who are named as your beneficiaries are still the ones that you want to receive the proceeds.

For example, if you should get divorced, would you still want your ex-spouse to inherit the funds? And, if you have a growing family, would you want only some of your children or grandchildren to receive the proceeds if the new family members weren’t named in the policy.

It is typically recommended that you review your insurance coverage at least once each year. But, if you have any type of major life change – such as marriage or divorce, the birth or death of a close family member, or the purchase of a new home (with a mortgage obligation) – then you should review all of the key aspects of your life insurance coverage – including who you have named as the beneficiaries.

How to Find Out If I am a Beneficiary of a Life Insurance Policy

If someone you know has recently died you may be wondering,  how do I find out if I am a beneficiary of a life insurance policy. The easiest way to find out is to look at the policy of the deceased.  If you do not have the policy you can call the insurance carrier and provide them with a policy number or the insured name and they may be able to assist.

If that does not work you can ask other family members such as a surviving spouse.  Calling the agent of the policy could work as well.  If the policy is lost we wrote an article you can read here on how to find a lost insurance policy.

How to Ensure that Your Life Insurance Proceeds are Allocated According to Your Intentions

The receipt of life insurance proceeds can oftentimes mean the difference between survivors continuing to maintain their current lifestyle or having to make some drastic changes going forward. For this reason, it is essential that you properly name the person(s) and / or entities that you wish to receive these funds so there is no reason for anyone to ever contest a life insurance beneficiary.

Working with an independent life insurance professional can help you go through this process. They can also go out into the life insurance marketplace and find the best coverage for your specific needs, as well as for your budget.

At Insurance Geek, we’ve already done the shopping for you. We work with more than 30 of the top-rated life insurance carriers, so we aren’t stuck with just a few policy options. If you’re ready to financially protect those you love with a policy that is customized for you, then Contact Us today.