Providing “peace of mind” for loved ones and ensuring their financial future may be as simple as adding a life insurance policy to your end-of-life plan. Few financial vehicles, for that matter, are more capable of providing for the people you care about most better than life insurance coverage with a comprehensive death benefit. It is worth noting, however, that a single life insurance policy may not be able to provide financial stability for everyone you love.
Instead, policyholders must choose the beneficiaries who will inherit the death benefit. On the surface, such a task seems simple enough, but it’s one that deserves some thought. It isn’t enough to choose the first name that comes to mind. While the first person you think of is often the best choice, there are some life insurance beneficiary rules you will want to follow, and some mistakes you will want to avoid.
At the very least, such an important decision deserves more than a moment of your time. This guide was designed to walk you through the process of choosing a beneficiary, and any other complimentary advice which may prove useful, including:
What is a Beneficiary for Life Insurance?
In its simplest form, a life insurance beneficiary is a person (or entity) named on a life insurance policy who is legally designated to receive the respective death benefit (provided all of the prerequisites are met) upon the policyholder’s passing. More often than not, beneficiaries are the people closest to the policyholder, like a partner/spouse, sibling or child. However, beneficiaries may also include entities like charities and non-profit organizations.
To be clear, beneficiaries are just that: the people who will benefit from the policy’s payout. They carry no extra responsibilities outside of notifying the insurance company and filing a claim for the death benefit.
How does a life insurance beneficiary differ from a Will beneficiary?
Life insurance and Will beneficiaries may appear similar on the surface, but there are subtle differences worth accounting for.
A life insurance beneficiary is legally designated to receive a death benefit after the policyholder passes away. The beneficiary will receive the death benefit as long as all the prerequisites of the policy are met and the policyholder is up-to-date on their premiums. Death benefits are often one lump sum of cash, but can also be paid out in installments.
Life insurance beneficiary rules are slightly different from those imposed on a Will’s beneficiary. A named beneficiary on a Will, for example, is designated to receive all of the assets associated with the estate that were specified for the beneficiary. That means the beneficiary of a Will may be entitled to cash and any other assets remaining after all debt obligations have been taken care of. Due to the more complex nature of estate plans, however, Will beneficiaries must wait for the probate process to complete before they can claim their inheritance.
How to Choose a Life Insurance Beneficiary
Nobody can tell you how to better choose a life insurance beneficiary than yourself. At the very least, you are well aware of where your priorities stand. Subsequently, it’s your money; you can leave it to whomever you like.
Having said that, choosing a life insurance beneficiary is a very personal experience and can factor in many variables, both subjective and objective in nature. Your job is to carefully consider each variable and determine the best destination for your death benefit. In doing so, carefully consider each of the following:
5 Mistakes to Avoid When Choosing a Life Insurance Beneficiary
The responsibility of choosing a life insurance beneficiary shouldn’t be taken lightly. Instead of choosing the first person that comes to mind, you will want to carefully consider each option. That said, what you do may be just as important as what you don’t do — if not more so. While they may not be the first things that come to mind, there are several mistakes you should avoid making when choosing a life insurance beneficiary, including:
Not being specific enough in naming beneficiaries
Not being specific enough in setting conditions for beneficiaries
Naming a minor as a beneficiary
Not specifying a contingent beneficiary
Assuming your written will wishes will transfer over to life insurance
1. Not being specific enough in naming beneficiaries
One of the most important life insurance beneficiary rules to abide by revolves around the naming convention used to identify the individual receiving the death benefit. To that end, it is of the utmost importance that your beneficiary is named clearly, without any room for misinterpretation. There should be absolutely no question as to who will receive the death benefit upon your passing.
In the event you aren’t specific enough, or the insurance company can’t determine who to give the death benefit to, it will name a default beneficiary. Typically, the estate will become the default beneficiary in the event a primary beneficiary can’t be named.
2. Not being specific enough in setting conditions for beneficiaries
Not unlike the first life insurance beneficiary rule, the second mistake to avoid has to do with exercising complacency. Namely, it’s never a good idea to be ambiguous with your intentions, especially when multiple beneficiaries are named.
Instead, remain diligent and set conditions for the death benefit. Be sure to clarify who gets what, and how or when the money is distributed. For example, it’s entirely possible to set conditions stating that a child can only use the money for educational purposes. Whatever your intentions are, make sure they are expressed clearly and concisely.
3. Naming a minor as a beneficiary
Many parents have turned to life insurance in order to provide a more secure financial future for their children. Proper coverage should arguably be enough to provide enough financial stability for the child until they reach adulthood and can generate their own income. However, there are some life insurance beneficiary rules that must be taken into consideration when leaving money to a minor. Most notably, insurance providers will not distribute death benefits directly to a minor.
That’s not to say parents can’t leave money to their children, but rather that to do so they must create a Trust in the child’s name or legally arrange for a guardian to manage the money in the meantime. Instead of naming the child as the direct beneficiary, parents are advised to name the Trust set up for the child. That way, parents can rest assured the death benefit will ultimately get to where it needs to go.
4. Not specifying a contingent beneficiary
Policyholders should never name a beneficiary without a contingent beneficiary; it’s always good to have a backup plan. In a perfect world, there will be no need to use the contingent beneficiary, but things don’t always go according to plan. In the event a primary beneficiary is deceased or unable to be reached, the contingent beneficiary will receive the death benefit. Specifying a contingent beneficiary will at least make sure the policyholder’s backup intentions are heard. If no contingent beneficiary is named and the primary can’t be reached, the death benefit will transfer to the policyholder’s estate and become subject to the probate process.
5. Assuming your written Will wishes will transfer over to life insurance
For one reason or another, far too many people make the mistake of assuming a written Will has the power to supersede a life insurance policy. While there are exceptions, the execution of an estate plan won’t supersede the rights of a beneficiary listed on a life insurance policy. According to standard life insurance beneficiary rules, the primary beneficiary on a life insurance policy has the right to claim the death benefit, regardless of what the Will says.
Learn More About How Your Life Insurance & Estate Plan Should Work Together
Life insurance is yet another tool at the disposal of those who wish to protect their financial legacy. With so much money on the line, however, it’s never a good idea to go into the process without a plan in place. Instead of going in blind, try to abide by the life insurance beneficiary rules and guidelines outlined above. Most notably take a proactive approach in choosing the right beneficiary and making sure your intentions are heard. Doing so will give you the “peace of mind” you sought out life insurance for in the first place.
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