Understanding Beneficiary Percentages: Does Life Insurance Factor In?

Life insurance is a financial product that provides peace of mind and financial security for you and your loved ones. Choosing a beneficiary is an important step in the process of purchasing life insurance, as they will receive the death benefit when you pass away. You can choose one or multiple beneficiaries, such as your spouse, children, a charitable organisation, or a trust. If you select multiple beneficiaries, you must allocate a percentage of the death benefit to each, totalling 100%. For instance, you could allocate 50% to your spouse and 25% to each of your two children. It's essential to carefully consider your options and seek legal advice when designating beneficiaries to ensure your wishes are carried out accurately.

Primary and secondary beneficiaries

When you take out a life insurance policy, you will be asked to name a primary beneficiary. This is the person or entity who is first in line to receive the death benefit from your policy when you die. Typically, this is a spouse, child, or other family member.

You can also name a secondary or contingent beneficiary. This is a backup who will receive the benefit if your primary beneficiary dies before you or at the same time as you. For example, if you name your spouse as the primary beneficiary and your children as secondary beneficiaries, the children will only inherit if your spouse dies before you or does not claim the benefit.

You can choose multiple primary and secondary beneficiaries, and you can decide how much of the benefit each receives. This is usually done by percentage, for example, 50%/50% or 65%/35%.

It's important to keep your beneficiary designations up to date, as your life changes. You can change beneficiaries at any time, although in some circumstances, such as specific terms of a divorce, you may need your current beneficiary's consent to do so.

Revocable vs irrevocable beneficiaries

When choosing a life insurance policy, it is important to understand the difference between revocable and irrevocable beneficiaries. A beneficiary is the person or entity that receives the benefits from your financial products. In the case of life insurance, this is the death benefit paid out by the policy.

A revocable beneficiary is someone who is designated to receive the death benefit when the policyholder dies but can be removed or changed at any time and for any reason without their consent. Most life insurance policies in Canada have revocable beneficiary designations.

An irrevocable beneficiary also receives the death benefit but, if the policy owner wants to change their mind about them being a beneficiary, both the owner and the beneficiary must sign off on the change. If both parties don't sign the necessary documents, that person remains a beneficiary on the policy.

An example of when an irrevocable beneficiary is useful is in divorce settlements or separation agreements, where each spouse lists their ex as an irrevocable beneficiary. This prevents a former spouse from changing the policy's designation without the other person's knowledge.

Another instance where an irrevocable beneficiary is required is when using a life insurance policy as loan collateral. The lender, such as a bank, would become the irrevocable beneficiary and is entitled to the death benefit. In exchange, the lender advances a percentage of the death benefit to the policyholder during their lifetime.

It is important to note that the choice of beneficiary does not impact the taxability of a policy. Additionally, the type of policy, such as Whole Life Insurance, Universal Life Insurance, or Term Life Insurance, does not affect whether a beneficiary is revocable or irrevocable.

Choosing a beneficiary

• Understanding the role of a beneficiary: A beneficiary is the person or entity that you legally designate to receive the benefits from your life insurance policy or other financial products. It is important to carefully consider who will receive the death benefit from your policy, as this decision cannot be changed after your passing.
• Types of beneficiaries: There are two main types of beneficiaries: primary and contingent. A primary beneficiary is the first in line to receive the death benefit, typically a spouse, children, or other family members. A contingent beneficiary, also known as a secondary beneficiary, receives the payout if the primary beneficiary dies before the policyholder or is unable to be located.
• Age and legal considerations: When selecting a beneficiary, consider their age. Naming a minor as a beneficiary is not advisable, as insurers typically do not disburse proceeds directly to minors. Instead, consider setting up a trust or appointing a trustworthy guardian to oversee the funds on behalf of the minor until they reach legal adulthood. If the beneficiary is legally disabled, you may need to create a special needs trust to ensure they receive the death benefit without losing any government assistance.
• Insurable interest: The beneficiary must have an "insurable interest" in your life, meaning they have more to lose than gain financially or otherwise by your death. Most insurers will require you to list the relationship you have with the beneficiary when filling out the designation form.
• Community property states: If you live in a community property state and used marital income to pay your life insurance premiums, your spouse may be automatically entitled to a percentage of the death benefit. These states include Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. Consult an expert to understand the specific laws in your state.
• Multiple beneficiaries: You can choose multiple beneficiaries and decide how much of the payout each receives. Ensure that the percentages add up to 100% and be as specific as possible when designating beneficiaries to avoid any confusion.
• Revocable vs. irrevocable beneficiaries: A revocable beneficiary can be changed, updated, or removed at any time without their consent. On the other hand, an irrevocable beneficiary designation requires the consent of both you and the beneficiary for any changes to be made.
• Updating beneficiaries: Remember to review and update your beneficiaries as your life changes, including events such as marriage, divorce, or the birth of children. This ensures that your wishes are accurately reflected and the right people are protected.
• Seeking professional guidance: Consult a financial advisor, attorney, or insurance expert if you have any questions or concerns about choosing a beneficiary. They can provide valuable guidance and help you navigate any legal or technical complexities.

Naming children as beneficiaries

It is possible to name children as beneficiaries of your life insurance policy. However, it is not recommended to name minor children as beneficiaries. This is because, in the event of your death, the death benefit cannot be paid directly to them. Instead, it will be sent in their name to the legal guardian of the minor child's estate. A court will appoint an adult custodian, who will be responsible for managing the funds from the payout. This process can take several months and delay the financial support you intended for your child.

If you wish for your life insurance payout to go to your minor child, it is better to set up a trust for them. This way, they will receive the benefit promptly and without having to pay taxes or legal fees. A trust also allows you to communicate how you want the money to be managed and when it should be distributed. You can designate funds for specific purposes, such as education or an allowance, and you can dictate that the funds are held until your child reaches a certain age.

Another option is to designate a custodian, who will claim and manage the death benefit on your child's behalf until they turn 18. This person should be someone you trust to act in your child's best interest.

If you have adult children, you can name them as beneficiaries in the same way you would any other person.

Changing, adding and removing beneficiaries

Changing, adding, and removing beneficiaries is a straightforward process, but it's important to understand the different types of beneficiaries and the implications of making changes.

Types of Beneficiaries

There are two main types of beneficiaries: primary and contingent.

• Primary Beneficiary: This is the person or entity who will receive the death benefits when the policyholder dies. Multiple primary beneficiaries can be named, and each will receive a specified percentage of the death benefits.
• Contingent Beneficiary: This person or entity will receive the death benefit if the primary beneficiary dies before the funds are disbursed or if the primary beneficiary cannot be located.

There is also a distinction between revocable and irrevocable beneficiaries.

• Revocable Beneficiary: This is someone who can be removed as a beneficiary at any time and without their consent.
• Irrevocable Beneficiary: To remove this type of beneficiary, both the policyholder and the beneficiary must sign off on the change.

Changing Beneficiaries

The policyholder can typically change, add, or remove revocable beneficiaries at any time without any penalty or fee. To do so, the policyholder needs to contact their insurance company and fill out a change of beneficiary form. This form may require information such as the policyholder's name, the new beneficiary's name, and the reason for the change. In some cases, a copy of the policyholder's death certificate may be required if the change is due to the beneficiary's death.

Adding Beneficiaries

When adding beneficiaries, the policyholder should specify the percentage of the death benefit each beneficiary will receive. This can be done as a specific percentage or through methods such as "per stirpes" or "per capita". It's important to ensure that the total percentages add up to 100%.

Removing Beneficiaries

Removing a revocable beneficiary is generally a simple process and can be done at any time. However, removing an irrevocable beneficiary requires their approval, and they must sign off on the change.

When to Make Changes

It's important to review and update beneficiaries after major life changes to ensure the right people are protected. Some situations that may prompt a review include marriage, divorce, the birth or adoption of a child, or the death of a beneficiary. Additionally, it's a good practice to regularly review your policy, such as during your employer's annual benefits enrollment, to ensure your beneficiaries remain up to date.

Special Circumstances

In certain circumstances, policyholders may need approval to make changes to their beneficiaries. These include:

• Granting power of attorney to someone else to make changes on their behalf.
• Living in a community property state, where the spouse may have rights to a percentage of the death benefit if premiums were paid using income earned during the marriage. In this case, the spouse must give written consent for someone else to be named as the beneficiary.
• Naming an irrevocable beneficiary, where both the policyholder and the beneficiary must sign off on any changes.

Why Updating Beneficiaries is Important

Keeping beneficiaries up to date ensures that the death benefit goes to the intended recipients. If a beneficiary predeceases the policyholder without any updates, the proceeds may go to a contingent beneficiary or the policyholder's estate, which could result in delays and additional costs.

Frequently asked questions