An important part of buying life insurance is choosing the individuals or institutions who will be named as beneficiaries on your policy upon your death. The significance of this decision cannot be overstated, and you should have as much information as possible to make the right choice. In this article, we’ll share details, tips, and recommendations to help you decide on the recipients of your life insurance benefit.
How to Choose the Beneficiaries of Your Life Insurance: Article Contents
What Are Life Insurance Beneficiaries?
All life insurance policies, regardless of the kind, have one thing in common: they are all backed by the stipulation that someone will receive a sum of money, also known as a death benefit, upon the policy-holder’s death. These end recipients are known as beneficiaries.
To avoid any complications in collecting the death benefit from the insurance company when they time comes, you must designate clear and unambiguous beneficiaries. Carefully choosing your beneficiaries can also help eliminate tensions between your heirs once you are gone.
In reality, you have every right to designate whomever you wish as a beneficiary, but it’s much better to make a thoughtful and informed decision. This is not as easy as it sounds, so read the suggestions in this article closely. There are legal conditions, vital life changes, and other situations that could turn complicate what seems like a simple choice.
First, you should know who you can name as a beneficiary:
• Spouses. This is one of the most common choices. Naming your husband or wife ensures that, upon the death of the policy holder, your significant other will have enough economic support to manage without you. That said, it is important to keep your spouse’s age in mind, as it may be wise to think about them sharing the benefit with other people if they are already of a certain age. It’s also important to consider any former spouses. It is fairly common in divorce agreements for a judge to order the husband to purchase a life insurance policy naming the ex-wife and children from the marriage as beneficiaries.
• Children. Frequently, people name their children as beneficiaries. The money they receive from the death benefit could pay their college tuition or other education fees, for example. In fact, this is one of the most common reasons people purchase a term life insurance plan. [Find more information on term life insurance here.] But as we will discuss further below, it’s important to consider whether your children are still minors, as this could make it difficult for them to receive the benefit.
• Trust funds. You can name a trust as a beneficiary and appoint an administrator who will manage it in accordance with your instructions. This is a very appropriate way to ensure that the money is used exactly as you wish.
• Parents. Many policy-holders name their parents as beneficiaries, especially if they are older and depend on their children’s help to survive. However, age is something to keep in mind in these instances. If your parents are very old, you may want to have other beneficiaries in mind.
• Banks. Many times, banks ask that customers take out life insurance policies as a requirement for a loan or mortgage. If the customer dies, the bank will use the insurance to cover the unpaid debt.
• Charities. Many people name charities, including NGOs, associations, and foundations as beneficiaries of their life insurance. It is a way to show solidarity and leave a memorable legacy.
• Companies. Companies tend to buy life insurance policies for key individuals in their organizations, such as the company’s owners. This can help limit losses in the case of their death. Some insurance companies offer policies designed specifically for these types of situations. In other cases, the policy-holder makes the decision to name a company as beneficiary.
• Inheritance. Rather than name specific beneficiaries, some people decide that their death benefit should be included in their inheritance.
Regardless of whom you choose, remember that you can name as many beneficiaries as you would like, but you must order them according to the amounts each one will receive. This system allows you classify your beneficiaries into three different types:
• Primary. Primary beneficiaries are the first line of individuals who will receive the death benefit. In other words, these are the people whom you designate as first to collect the money upon your death.
• Secondary. Secondary beneficiaries are people who will receive money if the primary beneficiaries have passed away. Again, you must be clear and unambiguous about secondary beneficiaries as well.
• Tertiary. In extraordinary cases, the money may have to be collected by a third line of beneficiaries. In the absence of primary and secondary beneficiaries, the tertiary beneficiaries can receive the death benefit.
In addition to determining your primary, secondary, and tertiary beneficiaries, you can also decide how they will substitute each other. This means that it is up to you, as the policy-holder, to plan the order of your beneficiaries. There are two main systems: per capita and per stirpes.
• Per capita beneficiaries. This means that you decide which specific individuals will be the primary, secondary, and, when applicable, tertiary beneficiaries. These individuals do not need to be related in any way, you simple provide their names.
• Per stirpes beneficiaries. This means that if a primary or secondary beneficiary dies, the right to collect the death benefit is passed on to their heirs or family. You do not decide who is next in line; rather, the right is transferred as an inheritance to the successors of the primary beneficiary.
Tips for Choosing Beneficiaries of Your Policy
Now that we have explained the different kinds of beneficiaries for a life insurance policy, we will share some guidelines that will help you carefully choose them and avoid making mistakes in doing so. Keep in mind that the death benefit can be a very significant sum of money, and this can sometimes bring more conflicts than relief. Keep these tips in mind when deciding who to name as beneficiary:
• Analyze the beneficiary’s circumstances. While you might be confident that leaving someone money is the right thing to do, in some cases it can bring negative consequences. For example, if you name someone who receives assistance or grants from the government for a disability, they could lose these benefits due to the increase in income that results from collecting the death benefit. Always take the circumstances of possible beneficiaries of your life insurance into consideration.
• Be cautious when naming minors. It is only natural for a mother or father to want to name their children as beneficiaries, but it’s not always that simple. In general, minors (anyone under the age of 18 or 21, depending on the state you live in) cannot directly collect the benefit, meaning the money will have to be placed in a trust fund. If you have not named an administrator of the trust, a court will have to appoint one, which can cause considerable delay in delivering the funds. Make sure you carefully analyze your options if you decide to name a minor as a beneficiary.
• Institutions and charitable organizations. As previously explained, your beneficiaries don’t necessarily have to be individuals. You can choose non-governmental organizations, charities, or other entities. This is a great idea if your family or loved ones are financially stable and you want to leave a lasting legacy upon your death.
• Trust fund. A very frequent option is to leave the money under the care of a trust managed by an administrator. This person will be in charge of carrying out your intended wishes for the money, giving it to those you choose or donating it over to charity, etc.
• Include it in your inheritance. You can also include the money from your death benefit in your inheritance. This will ensure that it will be divided among your heirs. This is not always advisable as it can cause delays in collecting the funds, among other issues.
• Choose beneficiaries. Don’t forget to choose the people who will be your beneficiaries, and most importantly, remember to name secondary beneficiaries as well as tertiary ones (if your policy allows.) If you die and there are no designated beneficiaries to collect the funds, it will be kept by the insurance company.
• Be precise. Language is very important in insurance policies. Don’t use generic terms like “descendants” or “heirs” to designate beneficiaries. Make sure that you name specific people and use the most accurate terms for relatives, including the right degrees.
• Review your policy occasionally. A good piece of advice is to periodically check your policy to re-assess the designation of your beneficiaries. If the first beneficiary you named passes away, you will want to replace them with someone else. It’s also possible that you’ll change your mind about the beneficiaries you initially named, and decide that others should receive the funds instead. You may have children after buying the policy and want to include them, or get a divorce and want to remove your former spouse as beneficiary of the death benefit. There are many reasons to readjust the beneficiaries on your policy.
What Not to Do When Choosing the Beneficiaries of Your Policy
In addition to the tips listed above to help you choose the beneficiaries of your life insurance policy, you should know about the most common errors people make in the designation process. If you’re aware of these mistakes, you can avoid making them yourself.
• Failing to notify beneficiaries. In many cases, beneficiaries may not be aware that they were designated. Don’t forget to let all the individuals or entities you have designated as beneficiaries know that you have named them so that they can receive the funds upon your death. Also, make sure that you let them know what the conditions of the policy are and where the documentation is kept to make it easier for them to claim your rights.
• Try not to name minors. If you do name minors, remember that they will not be able to have access to the money until they are of age of majority. This is why it is best to set up a trust fund and name an administrator if you are thinking of designating a minor as a beneficiary. This will ensure that they will be able to collect the funds as quickly as possible. You can also name a legal guardian or custodian who will receive the money and manage it on the children’s behalf.
• A will doesn’t change a policy. Many people think that a will or last testament will supersede a policy, but this is not the case. If, for example, you have a former wife named as a beneficiary, she will collect the funds, regardless of what is outlined in your will.
• Including the policy as part of an inheritance. Leaving the insurance policy as part of an inheritance is a sure way to cause significant delays in accessing the death benefit funds. Inheritances require long legalization processes, known as probate, and sometimes it is necessary to search for heirs for an extended period of time. No one can access the money from the insurance until all these processes have been completed. In addition, if you have creditors upon your death, they can make a claim against the value of the inheritance, and possibly take part (or all) of the death benefit. If you name direct beneficiaries, you will avoid these complications. And while inheritances are subject to taxes, death benefits are not.
• Not naming beneficiaries. If you fail to designate beneficiaries, the policy will transfer directly to your inheritance, resulting in the situation described above.
With this information, you’ll be able to name your beneficiaries correctly and with confidence. Choose wisely and enjoy the peace of mind you get from having life insurance. If you have any questions, reach out to your insurance agent for additional details.