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Understanding the Role of a Life Insurance Beneficiary

What Is a Life Insurance Beneficiary?

A life insurance beneficiary is the person or entity designated to receive the death benefit of a life insurance policy. Generally, they fulfill the following roles:

  • Life insurance beneficiaries can claim benefits once the policyholder dies. They may need to use some or all of the funds to settle the policyholder’s credit or tax debt.
  • Life insurance beneficiaries can be one or multiple people, including family members, friends, colleagues, or an organization. Some states require policyholders to name their spouse as a beneficiary.
  • Life insurance beneficiaries are legally entitled to claim funds regardless of the policyholder’s will or last testament, family interference, or the court system.

What Is a Life Insurance Death Benefit?

A life insurance death benefit is the payout that goes to the beneficiary when the policyholder dies. You may choose for your life insurance death benefits to be paid out in one of several ways, including in a lump sum, in installments, or in an interest building checking account. Some policyholders set up a trust to manage the funds, typically for dependents or minor beneficiaries.

The distribution of death benefits also depends on the “levels” of beneficiaries in your account. You may choose for the payout to be distributed “per capita,” split equally among your beneficiaries, or “per stirpes,” which pays out the death benefit to the “branches” of the family tree, common in situations where a policyholder is predeceased by his or her child.   

How Does Naming a Beneficiary Work?

You must complete a formal designation of beneficiary form online or in hard copy for your insurer to keep on file with your account information.  

Who Can Be a Life Insurance Beneficiary?

Choosing a life insurance beneficiary is a highly personal decision, but it is entirely yours to make. You may choose a person or people, a charity or nonprofit organization, or your estate. Policyholders commonly name their spouse and/or dependents. Some states require you to name your legal spouse as a primary beneficiary or request your spouse’s approval to name a different beneficiary.

Many individuals take out life insurance policies primarily to care for their family when they die, so naturally, they name their spouse and children as beneficiaries. Alternatively, you could choose a close friend, a corporate entity (possibly to settle a debt), or a favorite charity. You may also set up a trust or leave the death benefit to your estate, with instructions for distributing funds therein.

What Does the Beneficiary Do?

Beneficiaries may have some responsibilities besides simply receiving the death benefit. If a policyholder owes taxes to the IRS when they die, that debt becomes the responsibility of their estate. The IRS can and will seek to recoup unpaid income taxes from the estate, potentially taking the beneficiary to court over the issue.

The beneficiary may voluntarily settle any other outstanding debts, though non-IRS lenders are not always entitled to collect their payback from the estate legally. Creditors, for example, are not allowed to collect credit card or student loan debt from the beneficiary of a life insurance policy; however, a corporate entity may try to sue the estate for back debt.

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.

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.

Can You Name More Than One Beneficiary?

Yes, you may name multiple beneficiaries on your life insurance policy. You can specify a custom percentage of the death benefit for each primary beneficiary or split it equally among multiple primary beneficiaries. You can also instruct your insurer on distributing the funds if one of your primary beneficiaries predeceases you or cannot accept the award. 

You may also name multiple contingent beneficiaries; however, the nature of this process typically prevents more than one secondary beneficiary from receiving the payout. A life insurance policy may deliver a payout to multiple contingents only if all of the primary beneficiaries predecease them and the policyholder named dual contingents receives a shared percentage of the funds.

What Happens If You Don’t Name a Beneficiary?

If you do not designate a beneficiary, your death benefit automatically becomes part of your estate when you pass away. Failing to name a beneficiary opens up your estate to debt collectors and can delay payouts as your funds travel through the probate courts, often for years at a time. Relatives may try to take what they believe is their share of your death benefit.

Policyholders may have different reasons for not naming a beneficiary. Their insurer may not have adequately informed them that this is a necessary part of enrollment in a life insurance policy or may have procrastinated about completing the paperwork. Naming a beneficiary is critical to ensure your death benefit is paid out according to your exact wishes when you pass away.

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.

How Do You Determine Your Life Insurance Beneficiary? 

A variety of factors affect the process of choosing a life insurance beneficiary. First and foremost, policyholders should consider who currently relies most heavily on them financially and who will benefit the most from receiving a payout when they pass away. This tends to be a common criterion for policyholders looking to leave a lasting legacy for their spouse and children.

You may also consider more specific expenses when deciding who to name as a beneficiary. For example, you may choose a family member who requires extensive lifelong medical care or name your children primarily to ensure they have college funds when the time comes. Make sure the person or people you choose can handle the responsibility of managing such a major gift.

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.

How to Change Beneficiaries On Your Life Insurance

  1. Make sure you have a revocable beneficiary, meaning the beneficiary can be changed: Unfortunately, if you have an irrevocable beneficiary, the only way to change it is for the beneficiary to agree to forfeit their right to collect your death benefit. 
  2. You may change a revocable beneficiary at any time: Only you, as the policyholder, can change your beneficiary, and you may start the process by notifying your insurer of your intent to make this change. They may allow the new information to be input online or require you to mail a completed form to keep with your file.
  3. Ask your insurer if you need consent from your current beneficiary to make a change: Some insurers require written consent from your current beneficiary to be removed from an account. Whether or not this is the case for your policy, it is always a good idea to notify your current and soon-to-be beneficiaries of your intentions.
  4. Complete the beneficiary designation form: Carefully input the personal information of your new beneficiary on this form, keeping in mind that it should enable your insurer to locate the right person to receive your death benefit in your absence. Include information such as the beneficiary’s full legal name, social security number, and address. Keep a copy of the form for your own records before saving it online, emailing, or mailing it to your insurer.

Putting It All Together

Life insurance beneficiaries receive the death benefit of a life insurance policy. Policyholders often name their spouse and children but can choose any person, people, or entity to receive their life legacy. Naming a beneficiary or beneficiaries is critical to ensure your award is distributed according to your wishes after you die.

Insurers offer a variety of options for designating beneficiaries and distributing funds. Policyholders may choose to disburse the death benefit equally among multiple beneficiaries or assign a percentage to each awardee. They may also make a contingency plan in case the primary beneficiary cannot accept the benefits. Policyholders can easily choose or change their beneficiary at any time through their insurer.

Plan for your family’s future. Get a life insurance quote today.

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Plan for your family’s future. Get a life insurance quote today.

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