6 FAQs About Choosing a Life Insurance Beneficiary
By WHN’s Guest Columnist, M. Bryan Freeman
If you own assets, from bank accounts to life insurance, it’s important that you choose a beneficiary. A beneficiary is the person or entity who receives your assets or the proceeds of your assets (like the “death benefit” from your life insurance) after you die.
Why Do You Need a Beneficiary?
Choosing a beneficiary means that the proceeds from your life insurance will be directed by you and the funds will go to whom or to what you wish.
If you do not choose a beneficiary, the funds will go directly into your estate or may go directly to someone to whom you did not intend to leave your life insurance proceeds which may be determined by your state’s laws.
Naming a beneficiary for your life insurance is separate from your will and other estate-related documents. In fact, naming a beneficiary on a life policy (or other asset) can mean it is paid directly to your beneficiary and does not have to pass through your estate. So, even if there is a problem with your will or estate, the asset for which a beneficiary is named separately may be settled prior to other aspects of your estate.
Consult with your advisors (attorney, etc.) whether you should mention your life policy and its beneficiary in your will and other documents.
What Are the Types of Beneficiaries?
- Person or entity. A beneficiary can be a person or an entity. A husband or wife is a common beneficiary designation but you may also designate a non-spousal/non-legal partner, a former spouse or another loved one as a beneficiary.
WHN TIP – Former Spouses: Your life insurance company may have special requirements if you designate certain beneficiaries. For instance, if you designate a former spouse as your beneficiary, they may request you complete a form demonstrating your former spouse’s “non-spouse” status.
- Children. You can name minor children as beneficiaries, but would then also need to designate an adult custodian or trustee. Naming a custodian may be as simple as filling out a custodian designation form from your life insurance company. Designating a trustee would entail setting up a legal trust through an attorney.
- Your estate. Naming your estate as beneficiary can give you flexibility since you can always change your will to designate who gets what, but you also have to consider that having a death benefit paid to your estate increases your estate’s value, which can have tax liability and other implications.
- Charity or nonprofit organizations. You can name a favorite non-profit or charity organization as your beneficiary. You may do this to create certain tax or financial planning advantages; such choices should be discussed with your advisors (attorney, accountant, financial planner, etc.).
WHN TIP – Restrictions: Your life insurance company may have guidelines about whom or what can be named as a beneficiary or how you go about doing that. Or, they may at least ask for further information or documentation about your designation.
What Should You Consider When Choosing a Beneficiary?
A beneficiary is a very personal choice and will depend on your personal and financial circumstances.
Some people see death benefits as protection for their loved ones; some people see death benefits more as a financial transaction – a transfer of wealth. Consider whether there are people who depend on you for financial support.
- Would any people who depend on you for support be able to manage the death benefits themselves? (For instance, are they minors, mentally competent, etc.?)
- Are there people who will bear expenses in the event of your death?
- Are there financial or personal considerations for wanting to ensure your death benefits are passed directly or indirectly to certain people or entities or institutions?
In some instances, you may want to be very specific regarding your beneficiary. For example, name your spouse rather than putting “spouse” or “husband” as your designated beneficiary. Otherwise, an ex-spouse might receive the death benefit unintentionally.
On the other hand, identifying each of your children by name as a beneficiary could result in any subsequent children not being included in the distribution because they were not named as actual beneficiaries unless you updated your documents.
How Do You Formally Elect a Beneficiary?
- Notify your life insurance company (usually in writing) regarding your beneficiary selection, especially if this is a change from a previous election.
- Elect a beneficiary when you apply for or modify your life insurance.
- Notify your beneficiary that he or she has been chosen for such and provide basic documentation such as the name and contact information of the insurance company or the asset source, the policy number and type of asset.
WHN TIP – Keep It Up to Date: Has there been a change in your beneficiary’s health or welfare? Are there personal problems that might alter your decision? Discuss your beneficiary designation with your advisor at annual reviews.
When Should You Change/Update Your Beneficiary Designations?
Most life insurance policies will allow you to change your beneficiary at any time. The forms and procedures through which you make changes will vary from insurer to insurer.
It is a good idea to review insurance, financial and estate planning needs regularly, perhaps annually, especially after major life changes, such as marriage, divorce, the birth of a child, a child becoming an adult, and so on.
- In the event your named beneficiary is your son or daughter and they have divorced, their divorce decree may state the former spouse is entitled to a portion of future assets. It may be wise to consider your beneficiaries’ circumstances (when updating your estate and beneficiary information).
- Did you divorce? That doesn’t automatically change your ex-spouse as your designated beneficiary. You have to separately and formally change that, if you wish and if you are allowed to do so by the terms of your divorce and the resulting settlement.
You can name an “irrevocable beneficiary;” in general, this means that, while that person is living, you cannot change the beneficiary designation without his or her consent. However, if you no longer need or can’t afford the insurance you own and are considering a life settlement, and your beneficiary is irrevocable, there may be a problem with consummating the deal. Consult with your advisors on this issue.
What Are the Tax Consequences for the Beneficiaries?
In general, the beneficiary is responsible for any taxes owed on the death benefit they receive. Depending on the ownership of the policy, the proceeds could possibly trigger the estate tax even though the life insurance is tax-free to the beneficiary.
If you leave your life insurance proceeds to your estate, the death benefit is counted toward the value of your estate and may affect the tax liability. Conversely, if you designate a beneficiary directly on the policy and the death benefit does not pass through your estate, the value of the death benefit does not affect the tax liability of your estate.
It’s important that you thoughtfully choose a beneficiary for each asset you own, especially your life insurance. Make such a designation after learning about the process and your options, and only after conferring with advisors, like your insurance agent or attorney. With good information and sound advice, you can make the best decision for your individual circumstances.
Our thanks to M. Bryan Freeman, a licensed insurance agent for 29 years, and founder and president of Habersham Funding LLC, an Atlanta-based life settlement provider that does business nationally.
The information provided here is not meant to be a substitute for professional insurance or legal advice. Always check with a financial, legal, tax, or other advisor before making any insurance policy decisions or changes.