One of the most important decisions you need to make when purchasing life insurance is naming your beneficiaries.
Your life insurance beneficiary is the designated person or enitity that will collect your policy's death benefit when you die.
Although naming your beneficiary is pretty straightforward, there are still plenty of questions you may come across when making your decisions. Here, we answer 10 FAQs about life insurance beneficiaries.
In most states, the only requirement for a beneficiary is that they have an insurable interest in your life. This means that they would experience financial loss and/or hardship should you die.
Your spouse, children, and grandchildren definitely fit that definition. Aging parents who depend on you financially or for care also have insurable interest.
People who are not relatives can also be policy beneficiaries if they can prove insurable interest. Business partners do as well. A person can also have insurable interest if you have a legal obligation to make payment to them. A guardian that you appoint for your children can also be a beneficiary.
You’re also able to name non-people as beneficiaries, such as a charitable organization you want to support or a trust to help transfer assets.
There are, however, nine states in which you need your spouse’s consent to name somebody other than them as your beneficiary if you apply for the policy after getting married. These states have community property laws, which means all assets acquired during a marriage are owned 50/50 by both spouses. The nine states are:
- New Mexico
Every life insurance policy should name both a primary beneficiary and contingent beneficiaries. A contingent beneficiary is one who is entitled to the death benefit if the primary beneficiary has already died or cannot receive the benefit for another reason.
In many cases, a spouse is named the primary beneficiary of a policy, while the couple’s children (or a trust, see below) are named the contingent beneficiaries. If there are no children, a charitable organization can be named as the contingent beneficiaries.
A policyholder can also name more than one primary and/or more than one contingent beneficiary. To do this, you just need to list each beneficiary and designate a percentage of the death benefit to each one.
Your beneficiary doesn’t have to be another person. You can leave the policy’s death benefit to a trust. A trust is a legal arrangement that helps transfer assets from one party to another.
The most common reasons for naming a trust as a policy beneficiary are if the recipient of the trust’s assets is a child or somebody who can’t be trusted with a large sum of money.
When you establish a trust, you also appoint a conservator that disburses the trust’s assets on your behalf.
The policy owner is the only party who can change the policy’s beneficiary. As the policy owner, you’re typically allowed to change beneficiaries anytime simply by contacting the insurance company.
If you don’t have a primary beneficiary or if that person has died and there is no contingent beneficiary, the death benefit is paid to your estate. This makes the proceeds subject to the probate process, which is when a court determines who receives the assets in your estate. This is a lengthy process and it should be avoided by making sure you have primary and contingent beneficiaries.
In most cases, the beneficiaries of a life insurance policy do not pay taxes on their death benefit. One of the few scenarios where a life insurance payout affects a beneficiary’s taxes is if they receive the benefit in installment payments instead of a single lump sum.
That’s because the insurer will hold the principal amount in an interest-bearing account until the death benefit is fully paid out. Although the original death benefit is tax-free, the interest that accumulates is subject to income tax.
[ Related Read: Is Life Insurance Taxable? ]
It’s not uncommon for people to die without informing their beneficiaries of the existence of a life insurance policy. Unfortunately, insurance companies usually don’t find out about an insured’s death unless a beneficiary makes a claim, which they can’t do if they don’t know a policy exists.
This is why it’s important for insured people to inform their beneficiaries. The beneficiary should have a copy of the policy, which will make it easier for them to file a claim.
If you suspect you might be a beneficiary, the first step is to go through the deceased’s paperwork. In addition to looking for an actual policy, go through bank records to find payments to an insurance company or any correspondence from an insurer or an agent.
If that search yields nothing, there are two other avenues you can try.
One is the unclaimed property administrator of the deceased’s past states of residence. When an insurance company can’t find a policy beneficiary, it transfers the death benefit to the appropriate state’s unclaimed funds account.
Another option is the Life Insurance Policy Locator provided by the National Association of Insurance Commissioners. This service assists consumers in locating life insurance policies of deceased family members.
When NAIC receives a request, it asks participating companies to search their records for a policy of the person you’re asking about. The insurer will also contact you if you are the designated beneficiary of an unclaimed policy.
Because beneficiaries don’t always know of a policy, insurance companies do not impose any time limit on when a claim has to be filed. As long as the policy was active at the time of the person’s death, the claim has to be paid. Even if it takes several years for the insurance company to find the beneficiary, the claim will be paid.
If a beneficiary is denied the policy’s death benefit, it’s usually the fault of the insured. They may have died in a way that triggered a policy exclusion, such as committing suicide, lying on the policy application, or dying while committing a crime. Just about the only way an insurer will specifically deny a beneficiary payment is if the person murdered the insured.
It’s important for an insured to keep their beneficiaries up to date as their life changes. That’s because the benefit will go to whoever is listed on the policy regardless of whether that person is part of the insured’s life.
For example, if you get divorced and then remarried, but still have your first spouse listed as the policy beneficiary, the insurance company has no choice but to pay the death benefit to the first spouse.
The only way to change this is to contest the policy beneficiary through the court system. This is a lengthy, costly process and rarely results in the court changing the policy beneficiary.
Jack Wolstenholm is the head of content at Breeze.
The information and content provided herein is for educational purposes only, and should not be considered legal, tax, investment, or financial advice, recommendation, or endorsement. Breeze does not guarantee the accuracy, completeness, reliability or usefulness of any testimonials, opinions, advice, product or service offers, or other information provided here by third parties. Individuals are encouraged to seek advice from their own tax or legal counsel.