Choosing a life insurance policy is a major decision. Deciding on a life insurance beneficiary, the person who will receive the payout if something happens to you, is an ever bigger one. Top importance, in fact.
Consider this your road map to finding the right life insurance beneficiary to fit your family's needs.
This is the person who will receive the benefit from your life insurance policy if you pass away. The most common reason people take out term life insurance policies is because they’re responsible for financially supporting loved ones. So naming the appropriate loved ones in your policy is of the utmost importance.
If you were to pass away, the insurance company would pay out a death benefit to your beneficiaries, and those proceeds can go toward things like your funeral expenses or their household bills, childcare, college expenses or anything else.
For most married people, it’s an easy choice to name their spouse as the primary life insurance beneficiary. But, first, it doesn’t have to be that way. And, second, there’s no need to restrict yourself to a single life insurance beneficiary.
For example, if you’re chipping in to help your parents pay for their mortgage, you can set aside a percentage of the payout to help cover the balance on their home.
It’s up to you to decide what percentage of the payout goes to each life insurance beneficiary. Don’t hesitate to ask about any limits on how many beneficiaries you can name.
You can also choose contingent life insurance beneficiaries. In that case, the payout would only go to that person if the primary beneficiaries are no longer alive. For example, maybe your spouse is your primary beneficiary, but your child or sibling is your contingent beneficiary.
Choosing contingents can be a way to make sure the benefit goes where you want it to, even if your original plans aren’t possible.
Family might’ve meant Mom, Dad and two scrubbed-cheek kiddos in 1950s sitcoms, but that’s not real life. For many of us, family is beautifully, messily complicated, which can make the beneficiary section of a policy a little trickier.
Kirk Kinder, certified financial planner and owner of Picket Fence Financial, has seen a wide variety of families, all with a different makeup of people to take care of. Even in a married-with-kids family, others may appear on the beneficiary list.
“There’s a multitude of reasons,” he says. “There could be kids from previous marriages or kids outside of marriage. There could be charitable donations that you want to do. You could have siblings that aren’t doing very well, and you’re going to pass enough assets to your spouse, so you leave the payout to siblings. You can be very creative with it if you want.”
Other people might want to factor business partners, extended family or close friends into their life insurance beneficiary equation. Remember, this is your chance to look out for the people who rely on you financially, so set up the distribution in the best way you can to help cover your loved one’s needs.
Depending on your situation, a life insurance benefit can be one method of setting up an equitable inheritance (maybe you decide that kids from a previous marriage get the death benefit, while your current spouse and kids in that marriage keep your house and other assets).
If you’re a single parent, you’ve got a few extra steps to make sure your kids are covered properly. Life insurance companies won’t give a payout directly to minor children, so you’ll need to set up a trust or Uniform Transfers to Minors Act (UTMA) account, with a designated trustee to manage the money. (Here's more on how to set up a trust fund.)
You’ll probably want the funds to go to this account, not necessarily the person who’ll care for your kids if something happens to you. “You never want to leave it to the guardian, you want to leave it to the children,” Kinder says. “If you leave it to the guardian, it becomes the guardian’s asset and the guardian has no legal obligation to the kids.”
Theoretically, you should be able to trust your kids’ guardian to act in their best interest! But keeping your kids’ money separate is a simpler way to ensure the funds go toward your kids’ needs. If there’s any money left over once your kids have become adults and moved out of the guardian’s home, this would also ensure that the money continues to be theirs.
Of course, if you have a complicated family situation or complex financial needs, you should consult a qualified legal professional to help guide you.
Surprisingly, you can generally open a life insurance policy without making a particular beneficiary designation. If you do this, you’ve got two main options other than choosing a beneficiary.
First, you can designate the policy to go to your estate (i.e. follow the instructions in your will). That means letting state law determine who will collect the payout benefit. States vary, but many will start with your spouse and children and then move through your family tree to parents, siblings, nieces and nephews or other family until they find a surviving family member.
In certain cases, Kinder says, leaving the policy to the estate can be the best solution.
“I’ve seen before when someone changes their will a lot. It’s almost easier to say ‘leave it to the estate.’ That way you only need to update your will or trust documents to move the money the way you want.”
For example, a couple that wants to include grandchildren but doesn’t know how many they’ll eventually have might find it easier to write out their wishes in the will. That way, they can dictate that certain assets should pass to their grandchildren without updating their life insurance policy or beneficiary designation each time they have a new grandchild.
Still, this is only your best option if there are a lot of moving pieces. Although writing “refer to my will” is a simpler short-term solution, leaving the policy to your estate has some drawbacks, too.
Following the directions in your will involves going through the probate process, which can easily stretch out for years. If your loved ones will depend on the life insurance payout to help replace income for household expenses, this may be too long.
Probate records are also public documents, so if you want to keep things private, you should name beneficiaries directly on the insurance policy.
Once you’ve decided who belongs on your beneficiary list, you might feel like your work is done. Don’t fall into the trap of treating life insurance as a “one and done” deal. Kinder warns policyholders to watch out for these beneficiary mistakes:
Not updating your policy. Life can take various twists and turns, and it’s all too easy to forget to reflect major changes in your policy. “That’s a problem you see with divorce,” Kinder says. “If you forget to take your ex off the policy, if you die, the payout goes to your ex, not your current spouse.” Even if your will leaves everything to your current spouse and kids, it isn’t enough to supercede what’s written in your life insurance policy. (Here's what you should know about the finances of divorce and estate planning for blended families.)
Not utilizing “per stirpes.” Per stirpes is a fancy way of saying that each branch of the family should receive an equal share. So, if one of your kids passes away before you, the per stirpes rule says that the child’s share will go to his or her offspring, instead of reverting to the surviving sibling. Per stirpes only goes to the next generation, not a child’s spouse, so you’d need to designate your son- or daughter-in-law as a contingent beneficiary if you want that person to receive the share of the death benefit.
Leaving it to your estate without a will. If your beneficiary plans are complex, it can be easier to instruct the insurance company to refer to the plan in your will. The catch is, you need to actually write your will for this to work. If you don’t, state law could direct the payout to close relatives like your parents, without any consideration for your real desires (say, that single-parent niece you really wanted to help out financially).
There are many ways to set up the beneficiaries of a life insurance policy to fit the particular needs of your family, even if you’re outside the cookie-cutter norm. Give careful thought to who your beneficiaries should be and update your policy regularly so you can feel confident that your coverage does everything you want it to do, and helps all the loved ones it should.
Fabric exists to help young families master their money. Our articles abide by strict editorial standards.
This article is meant to provide general information and not to provide any specific legal advice or to serve as the basis for any decisions.
Fabric isn’t a law firm and we aren’t licensed to practice law or to provide any legal advice. If you do need legal advice for your specific situation, you should consult with a licensed attorney and/or tax professional.
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