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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. (Here's more on what you can do with a life insurance payout.)
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 named 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 having multiple beneficiaries and if there are 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 the contingent beneficiary 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 life insurance 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 beautiful, messy and 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.”
When naming beneficiaries, some 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 a beneficiary who is considered a minor, 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 and financial professional to help guide you.
Trust funds can help you dictate not just who should receive the money from your life insurance benefit but how. For example, you can dictate that your kids shouldn’t receive this big windfall until they reach a certain age, or you can include provisions if you want the money to go to someone with spending or gambling issues. You can set stipulations such as how the money is to be used—for example, if it should only go toward education.
When you set up a trust, you also choose someone you (ahem) trust to oversee the distribution of the funds. If you’re interested in potentially setting up a trust, speak to a qualified attorney and/or tax advisor.
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 named beneficiary.
First, you can designate the policy to go to your estate. That means letting state law determine what happens with 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. Depending on your situation when you pass, the proceeds may need to be used for other expenses, rather than going to your beneficiaries. If your loved ones will depend on the life insurance payout to help replace income for household expenses, this may be too long and may reduce what they receive, if anything.
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 life insurance 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 former spouse, 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). Plus, not every life insurance policy allows you to simply designate your estate as the beneficiary.
Additionally, you might want to consider federal regulations around Social Security when deciding who to name as your beneficiary, to avoid inadvertently disqualifying them from various benefits. For example, someone who gets Social Security because they’re elderly, blind or disabled could see their benefits reduced or suspended if a big inheritance raises their income level.
If the insured person passes away, the beneficiary will need to get in touch with the insurance company as soon as possible. Often, they’ll be able to do this online (for example, if the insured had a policy through Fabric, the beneficiary could simply message customer support on our website to get the process started).
The beneficiary will generally be asked for some paperwork and supporting evidence to verify that the insured did, indeed, pass away. That will likely mean a certified copy of the death certificate.
There’s no guaranteed time frame by which the beneficiary will receive the death benefit, but this will usually be a much faster turnaround than going through the probate process.
Most life insurance policies have a two-year contestability period. That means that if the policyholder passes away within the first two years of their coverage, the insurer may take a closer look at the cause of death. In some cases, insurance carriers require an investigation to confirm that the cause of death is covered and that the policyholder didn’t answer untruthfully on his or her insurance application.
If the claim takes place after the contestability period and the insurer determines that no investigation is needed and the claim received is in good order, payment of the death benefit will be processed within three business days of receipt.
Claims that are under investigation cannot be paid until the investigation is complete.
Generally speaking, you’ll usually want to designate a beneficiary at the time you apply for a life insurance policy. That’s because most people choose to apply because there are specific people in their life they want to help if something were to happen to them. (For example, they’re applying for life insurance to help protect a spouse or child financially.)
That said, if you pass away while your policy is active and you don’t have a named beneficiary, or if your beneficiary passes away before you do, then the death benefit from the insurer will become part of your estate and is likely to go through the probate process. That means that a judge would be responsible for figuring out who should receive the money from the life insurance policy. This is usually determined by who’s most closely related to you.
Some states have “community property laws,” which essentially state that you and your spouse are equal owners of all assets. In these states, your death benefit might go straight to your spouse automatically, regardless of whom you’ve named as a beneficiary, unless your spouse has given written consent for you to do otherwise.
Which states have community property laws? Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin. Alaska, South Dakota and Tennessee have elective community property laws, which essentially means that married couples get to choose whether to be governed by these rules.
In short, the policyholder. So, let’s say you apply for a policy because you support your aging parents and want to help make sure they’d be covered if something happened to you. As the person who owns the policy, you’d have the power to change who you designate to receive the benefit should you pass away.
For the most part, the death benefit from a life insurance policy is tax-free for the beneficiary. A few niche exceptions include:
If your beneficiaries choose to receive the death benefit in installments rather than all at once, they’ll earn interest on the portion that the insurer holds for them over time. That interest could be taxable.
If you have a whole life insurance policy and borrow against your cash value, you could be responsible for taxes on any amount that exceeds what you’ve paid into the policy. (What’s cash value? What’s the difference between term and whole life insurance?)
If you have a whole life policy and contribute a very large amount to your premiums, in some cases that could be construed as a “modified endowment contract” and could face taxes.
If you leave your life insurance benefit to a very large estate, it could be subject to estate taxes.
Here’s more detail on whether and how life insurance could be taxable.
If the beneficiary is alive and a valid beneficiary (for example, a legal adult), they generally shouldn’t be denied a death benefit if the insured person passes away. In a few rare cases, such as if the beneficiary is incarcerated, it’s possible that they may not be eligible to receive a life insurance payout. And, um, despite what movie plotlines might have you think, if there’s evidence that a beneficiary murdered a policyholder, they almost certainly won’t be able to receive the insurance death benefit.
A claim might be investigated by the insurance company under certain circumstances, such as if the insured party committed suicide within the first two years of coverage, or if they misrepresented themselves on their original life insurance application.
Some insurers let you designate whether your beneficiary selection should be revocable or irrevocable. A revocable beneficiary is one that can be changed or removed at any time. By contrast, if you are the policyholder and designate an irrevocable beneficiary, you won’t be able to change that selection down the road unless you have the consent of that original beneficiary.
Not all insurance policies have the option to appoint irrevocable beneficiaries. For example, the term life insurance policy offered through Fabric doesn’t support this option.
There are many ways to set up life insurance beneficiaries of your plan 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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Accidental Death Insurance policies (Form VL-ADH1 with state variations where applicable) and Term Life Insurance policies (Form ICC16-VLT, ICC19-VLT2, and CMP 0501 with state variations where applicable) are issued by Vantis Life Insurance Company (Vantis Life), Windsor, CT (all states except NY), and by The Penn Insurance and Annuity Company of New York (NY only). Coverage may not be available in all states. Issuance of coverage for Term Life Insurance is subject to underwriting review and approval. Please see a copy of the policy for the full terms, conditions and exclusions. Policy obligations are the sole responsibility of Vantis Life.
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