Choosing your beneficiary is the most important decision you will make when you apply for term life insurance.
A close second and third are choosing the amount of coverage and term length. After all, you can do your homework and select the perfect amount of coverage, but if you leave it to the wrong person what good is it?
With this in mind, let’s make sure you get it right the first time; even though you will get another chance. More about this later. For now though, these guidelines will set you on the right path.
What is a life insurance beneficiary?
A beneficiary is the person or entity who will receive the death benefit from your policy if you die. The death benefit is also called the coverage amount or policy proceeds, but we’ll stick with death benefit to keep things simple.
The death benefit is usually paid by the life insurance company directly to the beneficiary. This money is usually not subject to income tax, but may be subject to estate tax.
A beneficiary must have insurable interest.
When life insurance companies review beneficiary designations on applications, they are looking to see if there is an “insurable interest” between the insured person and the beneficiary. For life insurance purposes, a beneficiary has insurable interest in the insured person when loss of that person would cause the beneficiary to suffer a financial loss.
Think about it in terms of financial dependence. If someone is financially dependent upon you, they are likely a reasonable choice for a beneficiary. The most obvious relationships are husbands/wives and parents/children, although there are many other options. There are also exceptions such as charitable donations, which we’ll look at more closely.
The 3 Beneficiary Categories
Now that we know a bit more about what a beneficiary is, let’s look at the three categories of beneficiaries you’ll need to consider for your policy.
- Primary – The primary beneficiary is the first in line to receive the policy death benefit. One example, and the most common arrangement, is spouse/spouse. The first spouse is the insured person and the second spouse is the primary beneficiary.
- Contingent or Secondary – The contingent beneficiary is the second beneficiary in line to receive the policy death benefit. Their receiving the death benefit is contingent upon the absence of a primary beneficiary, such as when the insured person and primary beneficiary die at the same time.
- Tertiary – Tertiary means of the third order. Therefore, the tertiary beneficiary is third in line to receive the policy death benefit. As with the contingent beneficiary, the tertiary beneficiary’s receiving the death benefit is contingent upon the absence of both a primary and a contingent beneficiary. It’s not very common to name a tertiary beneficiary on a term life insurance policy. In fact, most life insurance applications don’t even include a tertiary beneficiary section.
You can have multiple beneficiaries.
So far we’ve talked about a beneficiary in the singular form. But you can certainly designate multiple beneficiaries of each type for your policy. For example, you can have two primary beneficiaries and three contingent beneficiaries. Or you can have five primary beneficiaries and no contingent beneficiaries. There really are no limits to the number of beneficiaries you designate, as long as each one has insurable interest.
When selecting multiple beneficiaries, you’ll need to make sure the percentage split between all beneficiaries in a category total up to 100 percent. If you designate one primary beneficiary to receive 50 percent of the death benefit, the remaining primary beneficiaries must receive the remaining 50 percent between them.
This table shows two examples of splitting the death benefit among multiple beneficiaries.
If you do add multiple beneficiaries, you can also add a special designation to ensure the policy death benefit goes where you want it to.
- Per Capita – This means if a beneficiary dies before the insured person, the remaining beneficiaries will receive the deceased beneficiary’s share of the death benefit. This is the default method of distribution on most modern policies and how the life insurance company will handle the proceeds unless directed otherwise.
For example, you name your parents as your primary beneficiaries. If one of your parents dies before or at the same time as you, the surviving parent will receive all of the death benefit.
- Per Stirpes – No, not a typo. Per stirpes means if a beneficiary dies before the insured person, that beneficiary’s share will pass to her heirs and not to the remaining beneficiaries as with per capita.
For example, you name your three brothers as your primary beneficiaries. If you one of your brothers dies before you (or at the same time), his share will go to his survivors and not to your remaining two brothers.
Common Types of Life Insurance Beneficiaries
So we know a beneficiary must have insurable interest in you; meaning they would suffer a financial loss if you died. There are literally dozens of scenarios that could satisfy this requirement. Here we’ll take a look at some of the most common types of beneficiaries.
- Spouse – This is probably the most obvious and certainly the most common beneficiary designation. Even if the insured person is a non-working spouse, the surviving spouse would likely suffer financially upon his death.
- Ex-spouse – This is one you may not have expected. However, it’s quite common in divorce cases to have a court-order to provide life insurance for the ex-spouse and/or children.
- Children – Another obvious designation, but be careful if the children are minors. Depending on state law, the proceeds could go to the children’s court-appointed legal guardian or set aside in a trust. This may not be what you want to happen.
- Will/Trust – Creating a will and/or trust is the most effective way to ensure the policy death benefit goes exactly where you want it to. The document can spell out proceed distribution for any number of scenarios, as well as specify guardianship for surviving children.
- Parent – Parents are often named as beneficiaries. One example is when the parent is older and is financially dependent on you for support. Another is when your parents have cosigned for your student loans. A life insurance policy can help them repay those loans if needed.
- Bank – Banks often require life insurance policies as collateral on loans. A common arrangement is to name the bank as primary beneficiary to receive the balance of the loan upon your death. You can then name a contingent beneficiary to receive the remaining death benefit.
- Corporations or Partnerships – Companies often take out business life insurance policies to protect themselves from things like the loss of a key employee or the death of an owner. Examples of these types of policies are Key Person, Bull-Sell and Business Continuation. Often the company is named as the beneficiary.
- Others – Other beneficiary designations can include significant others, domestic partners, siblings or charities. Remember, the key is that an insurable interest is present. For example, if you wish to leave money to a charitable organization, you’ll need to demonstrate a pattern of giving to the specific charity. This can apply to a variety of situations in addition to these.
Nothing is permanent, but change.
Okay, maybe that quote is a bit profound, but you get the point. Which is, you are not locked in to your initial beneficiary designations forever. Not even close. Actually, you can easily change them as often as you’d like, throughout the life of your policy. Just remember, only the policy owner can do this. The policy owner and the insured person are often one and the same, but not always.
[clickToTweet tweet=”Nothing is permanent, but change. — Heraclitus” quote=”Nothing is permanent, but change. — Heraclitus”]
An estate planning attorney can be your best friend.
As we mentioned, the most effective way to ensure your life insurance policy does exactly what you want it to is to establish formal documentation such as a will or trust. In the absence of these, you risk the proceeds falling in to unintended hands or worse, your estate. The latter means the money could be tied up in probate until the stated decides what to do with it.
You can avoid these potential headaches by consulting a good estate planning attorney. There is so much variation and change among state and federal law that it wouldn’t be prudent for us (or any insurance agent) to advise you on these matters. There’s simply too much at stake for you to skip this important step.
Once you select your beneficiaries, be sure to let them know! You certainly don’t want them to be in the dark about your wishes, especially during such an emotionally difficult time. Do all you can now to make things easier for them if the time comes.
And if you’re still unsure whom to name as your beneficiary, ask your agent for help. Think about why you are buying the policy in the first place. It’s likely someone is financially dependent upon you.