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Life Insurance

Understanding the Role of a Life Insurance Beneficiary

The beneficiary of a life insurance policy is tasked with receiving a policyholder’s insurance payout after they die.

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A life insurance beneficiary is a person legally designated to receive a policyholder’s insurance payout after they die. Choosing a beneficiary for your policy is a big decision, as you need someone who can responsibly handle your end-of-life expenses with the payout.

The Role of the Beneficiary in Life Insurance

Life insurance is a type of insurance policy you can buy that offers a payout upon your death. This payout, better known as a death benefit, is a cash payment that goes to the beneficiary of your choice.

At a minimum, death benefits are meant to be used to pay for your final expenses, such as your burial costs and outstanding debts. The beneficiary can also use it to replace your lost wages, especially if you were a primary income provider for the household. That said, there are no rules on how the beneficiary spends the death benefit.

If you neglect to choose a beneficiary for your policy, the insurance company will still pay the death benefit, but it will go into your estate instead of a designated person or entity. A local probate court then typically decides how to distribute the funds. They do consider if there is a will in place. However, this is not a recommended course of action because the process can be drawn out and inefficient. It also means you ultimately would not have control over who receives your death benefit.

Life Insurance Beneficiary vs. Will Beneficiary

Life insurance beneficiaries and will beneficiaries are similar concepts, but with a few differences. Whoever you name as your life insurance beneficiary receives your death benefit, but nothing else. For example, they are not guaranteed to receive any of your other assets or possessions.

Likewise, a will beneficiary, or heir, is not entitled to your life insurance payout, even if you designate it in your will unless they are also the beneficiary on the life insurance policy. The insurance provider is legally obligated to pay the death benefit to whoever you have named in your policy, overriding whatever directives are found in your will. Instead, your will is meant to describe how your other assets — like your property, savings, or possessions — should be divided after your passing.

It is possible to designate the same person to be both your life insurance beneficiary and your will beneficiary. To do this, you would need to name them on both your policy and in your will.

Choosing a Beneficiary

When you take out a life insurance policy, it is best to choose your beneficiary right away to avoid any issues if you pass away unexpectedly. However, choosing a beneficiary is not a decision to take lightly, as you need to ensure the person you designate is capable of handling your death benefit.

The main person you want to receive your death benefits is called a primary beneficiary. However, if that person dies before you or is otherwise unable to claim your benefits, you can also choose contingent beneficiaries. It’s a good idea to have a secondary beneficiary so your death benefits do not end up in probate court.

Naming an Individual as Your Beneficiary

For primary beneficiaries, many people choose close family members like a spouse or child. Consider how financially dependent your loved ones are on your income. For example, if you are the primary income for your spouse, making them the beneficiary for your death benefits ensures they can have a financial cushion after your passing.

One thing to keep in mind is that your death benefits may disqualify your beneficiary from receiving government assistance. While the IRS does not count life insurance proceeds as gross income, some services like Medicaid may take your total assets when determining if you may be eligible into account.

Spouse or Family Member Beneficiary

Choosing a spouse or family member is a very common option for policyholders. They are likely closest to you and may be greatly affected by your passing. Your death benefits can give them some financial security as they adjust to the absence of your income. It can also give them the funds they need to settle your final affairs so that they will not have to use their own money to pay for your funeral, mortgage, or taxes.

Non-relative Beneficiary

Some people may choose to name a non-family member as a beneficiary. In most cases, there is no problem with this. However, some states have community property laws that could make things a bit tricky. In the following states, you may need to have your spouse waive their rights as beneficiary before you can assign another person in their place:

  • Arizona
  • California
  • Idaho
  • Louisiana
  • Nevada
  • New Mexico
  • Texas
  • Washington
  • Wisconsin

You may choose a non-relative beneficiary if you have a close friend that will be handling your expenses. If your spouse and other family members have their own income sources and might not need a large cash sum after your death, you may be able to select a non-relative beneficiary.

However, many insurance companies will require an explanation as to why this person was chosen to ensure they are acting in your best interest. Many people also choose their godchildren or long-term partners as their life insurance beneficiaries instead of a blood relative.

Child or Minor Beneficiary

It is generally not a good idea to name a minor as your life insurance beneficiary because if you die before your minor beneficiary turns 18 years old, there could be hurdles to paying out the death benefit. Many states have limitations preventing children under 18 from being paid death benefits.

The process varies by state, but in many cases, the death benefits would be placed into a trust or handled by an adult custodian until the child’s 18th birthday. This process typically requires court sessions to help mediate, which ultimately would lower the actual money available for the underaged beneficiary because of court fees.

Naming an Entity as Your Beneficiary

Life insurance beneficiaries don’t have to be individuals. You can also leave your death benefits to a trust, charity, or other organization. If your loved ones are financially comfortable, this could be a good way to give back to your favorite organizations.

Trust Beneficiary

A trust beneficiary is when your death benefits get put into an account with specific limitations. You can designate exactly what organizations should receive your benefits and how much they should receive. Upon your death, the trustee would distribute the funds based on your requests.

Many people choose this if they want to give to multiple organizations. Creating a trust also ensures your benefits don’t get held up in probate court, meaning your charities or other organizations can receive their money without delay.

Charity Beneficiary

Creating a charity beneficiary means that your death benefits go directly to them. This is ideal if you are set on making sure your money ends up in the hands of a specific organization. To make things official, you may need to provide your insurance company with the tax ID number of the charity. Because you can have more than one beneficiary on a policy, you don’t have to give the entire sum to charity — you can also split some benefits to go to your family or other individuals.

Estate Beneficiary

An estate beneficiary is when your death benefits are lumped with your other assets and possessions. This is what happens by default if you don’t choose a beneficiary or if all your named beneficiaries die before your death benefits can be distributed.

There are a few reasons you may want to roll your life insurance into your estate. If you have a lot of property and assets to divide up, adding in your death benefits can help make sure your extended family receives equal shares of the policy. However, adding your death benefits to your estate can increase your estate tax, so be careful with this approach.

Naming Multiple Beneficiaries

Naming multiple beneficiaries on your policy can ensure multiple loved ones receive financial support after your passing. You need to list every person you want to receive benefits, along with the percentage each person should get. You can include entities as well. For example, you might want to leave 50% to your spouse, 25% to your child, 15% to your childhood friend, and 10% to your favorite charity.

If you’re choosing this method, you may also want to think about per stirpes and per capita. These are two legal terms that explain what would happen if a beneficiary passes away before you. In per stirpes, your death benefits pass on to the beneficiary’s heirs. In per capita, your benefit percentages are recalculated to exclude the beneficiary who passed away. The method you choose depends on whether you want to keep your benefits among a specific group of people or would like them to pass on to your loved one’s heirs.

Changing Beneficiaries On Your Policy

Some common reasons for wanting to change your life insurance beneficiary include:

  • You got a divorce
  • You got married
  • Your other beneficiaries have passed on
  • You had a falling out with your beneficiary
  • You had additional children
  • You want to donate your money after your death

Luckily, changing your beneficiaries is fairly straightforward. You would contact your insurer and may be able to submit a paper or online form or make a phone call to confirm the changes. The company may ask you for some personal information about the beneficiary, including their:

  • Birthdate
  • Contact information
  • Legal name
  • Relationship to you
  • Social Security number

Only the policyholder can change a beneficiary unless you’re on a joint policy or have given someone else legal permission to make the change.

Claiming a Death Benefit as a Beneficiary

While some life insurance companies may attempt to contact the beneficiary upon the policyholder’s death, this process can take a long time because the insurer does not have a way of knowing automatically that the policyholder has died. Therefore, your first step should be to notify the insurance company of the passing of the insured. This typically involves sending the company a certified copy of the death certificate, a claim form, and a copy of the life insurance policy. You may also need to verify your identity by providing proof of your social security number.

Many insurers process death benefits within 60 days of receiving notification of the death and the claim. They use this time to confirm your identity and ensure that there is no fraud or uncertainty around the death that could make the policy invalid. When the death benefits arrive, they are typically paid in one lump sum unless you choose to have them paid across an extended time period or in another offered manner.

Do Research If You’re Unsure About a Policy’s Beneficiary

If you think you may be a beneficiary but you’re not sure, you may have to do a bit of research. This may include asking the policyholder’s closest family members, looking for the policy paperwork, or contacting the insurer. If that fails, you can also try getting help from the National Association of Insurance Commissioners. The organization maintains a Life Insurance Policy Locator Service that helps to track down unclaimed life insurance policies.

How Are Life Insurance Beneficiaries Paid Out?

Life insurance beneficiaries typically receive death benefits as a check or bank transfer. You may be able to specify which method you prefer after reaching out to the insurance company and talking through your options. You can also decide whether you’d like to receive your death benefits as a lump sum payment, installment payment, trust, or checking account, though not every insurer offers all of those options.

Lump Sum Payment

A lump sum payment is when you get the entirety of the death benefit at once. It’s a convenient option if you know you have a lot of expenses to take care of and need the money right away. For example, lump sum payments are good if you need to pay off the deceased’s funeral or mortgage. In addition, lump sum payments are not taxed.

Payment in Installments

If you’d prefer to receive recurring payments over a span of time, installment payments may be a good option. These are paid on a recurring basis and can be scheduled to mimic the regular cadence of a paycheck. This method can help if you need monthly help with your living expenses.

In Trust

Beneficiaries typically don’t get to choose if they want their benefits in a trust. Usually, the deceased sets up a trust before they die as a way to more closely define where their benefits go. Typically, this is used for minors who aren’t yet of age.

Insurer Checking Account

In some cases, the insurance company lets you keep the payout in an interest-bearing account. You can then get a checkbook for withdrawing funds any time you need them. These accounts are FDIC insured for up to $250,000. This could be a good option for younger beneficiaries who don’t need the money upfront.