Beneficiaries And Life Insurance: Dividing Policies And Payouts Fairly

Choosing a life insurance beneficiary is a crucial aspect of owning a life insurance policy. A beneficiary is the person or entity that receives the death benefit from your policy if you pass away. While most people prefer to leave 100% of their death proceeds to one primary beneficiary, it is important to also consider secondary and tertiary beneficiaries to avoid unnecessary complications. When it comes to splitting life insurance proceeds among multiple beneficiaries, there are a few common methods: per capita, per stirpes, and a life insurance trust. Per capita distribution means the proceeds are divided equally among all surviving beneficiaries, regardless of their family branch. On the other hand, per stirpes distribution entails splitting the proceeds by family branch, with each branch receiving an equal share. For example, if one of your two children passes away before you, their share would go to their children, while your other child would receive the remaining share. Alternatively, you can set up a life insurance trust and designate a trustworthy estate-planning attorney to oversee it, ensuring your beneficiaries receive their shares as intended. It is also important to keep your beneficiary designations up to date and be as specific as possible to avoid disputes.

Primary and contingent beneficiaries

When you take out a life insurance policy, you can name a beneficiary or multiple beneficiaries. If you don't name a beneficiary, your death benefit goes to your estate.

There are two types of beneficiaries for life insurance policies: primary and contingent. A primary beneficiary is the first person in line to be paid your policy's death benefit when you die. A contingent beneficiary, also called a "secondary beneficiary", receives the payout if the primary beneficiary passes before you do or is otherwise unable to accept the benefit.

You can have multiple primary and multiple contingent beneficiaries. If there are multiple primary beneficiaries, the death benefit will be split between them. If there are multiple contingent beneficiaries, they will only receive the death benefit if none of the primary beneficiaries are reachable.

When choosing your beneficiaries, it is important to consider who relies on you financially, who would need to pay your final expenses, and who you would like to leave money to.

It is also important to decide whether you want to divide your policy's benefit per capita or per stirpes. Per capita means that the benefit is split equally between the beneficiaries. Per stirpes means that the benefit is divided by family lineage. For example, if you have three children and one of them passes away before you do, per capita means that the remaining two children will each receive a third of the benefit, while per stirpes means that the deceased child's share will be divided between their children.

Finally, make sure to review your policy annually and make any necessary adjustments, such as splitting beneficiaries or changing your beneficiary designation from revocable to irrevocable.

Irrevocable vs revocable beneficiaries

When setting up a life insurance policy, you can choose who will receive the payout, also known as the death benefit, when you pass away. You can also decide whether your chosen beneficiary is revocable or irrevocable. This is an important decision, as it will determine how much control you have over your policy going forward.

Revocable Beneficiaries

A revocable beneficiary is the default option for most policies. This means that the beneficiary can be changed or removed by the policyholder at any time, without the beneficiary's consent. The policyholder can also make changes to the portion of the death benefit that the beneficiary will receive, either increasing or decreasing the amount. There is also no requirement to notify the beneficiary if the policy is cancelled.

Irrevocable Beneficiaries

An irrevocable beneficiary, on the other hand, cannot be removed or altered without their consent. This means that the policyholder cannot make changes that would impact the beneficiary's rights to the death benefit without their approval. Irrevocable beneficiaries have a guaranteed right to the benefit, providing security for both parties. However, this also means that the policyholder loses some flexibility, as they cannot make changes without the beneficiary's permission.

When to Choose an Irrevocable Beneficiary

Irrevocable beneficiaries are often chosen in situations where financial support must be guaranteed, such as in loan agreements or divorce settlements. For example, a lender may be named as an irrevocable beneficiary when a policy is used as collateral for a loan. This ensures that if the borrower passes away before the loan is repaid, the lender will receive the insurance payout. Irrevocable beneficiaries are also common in cases of divorce, especially when minor children are involved, as it ensures the children's financial protection.

Advantages and Disadvantages of Irrevocable Beneficiaries

The main advantage of naming an irrevocable beneficiary is that it ensures the death benefit goes to the intended person or entity. It also provides legal and financial stability, particularly in situations like divorce settlements or loan agreements. However, the primary disadvantage is that it reduces flexibility, as the policyholder cannot make changes without the beneficiary's consent. This can become problematic if circumstances change.

Naming minors as beneficiaries

While it is possible to name a minor child as a life insurance beneficiary, it is not recommended. Minors cannot be paid the death benefit directly due to legal restrictions. If you die before your child is legally an adult, the probate court will name a guardian for the minor's estate, and the guardian will retain oversight over the estate and its money until the child reaches the legal age of majority. This process can be lengthy and costly, preventing the money from being used as intended.

There are a few ways to avoid this scenario and ensure that your minor children receive the payout:

Setting up a Trust

A trust can be an effective solution for leaving money to children. You can set up a life insurance trust and appoint a trustee to oversee the funds and distribute the money according to your wishes. However, there are costs involved, and the trust must be valid and active at the time of your death.

Designating a Custodian

If you are unable to set up a trust, you can name a custodian to help your minor child claim and manage the death benefit. A custodian is responsible for claiming the death benefit on the child's behalf and will manage the money until the child turns 18. It is important to name a custodian you trust to act in your child's best interest.

Naming your Spouse as Beneficiary

If it makes sense for your family, you can name your spouse as the primary beneficiary and your trust as the contingent beneficiary. Your spouse can continue managing your household finances and set money aside for your child's future. If both parents pass away, the trust can take over.

Naming your Estate as Beneficiary

While this option may result in the payout being subject to estate tax, it is still an option to consider. However, it is important to note that even if you have a will, your estate may get held up in probate court, delaying the payout and incurring additional costs.

Naming charities as beneficiaries

Identifying the Right Charities:

It is crucial to identify the specific charities you want to support. Many charities have similar names, so ensure you have the full legal name and their EIN (Employer Identification Number) or tax identification number. Websites like Charity Navigator can help you verify this information and assess how efficiently charities spend their donations.

Understanding the Process:

Naming a charity as a beneficiary is a straightforward process. Simply include the charity's name and contact information when choosing or updating your beneficiaries. You can allocate a specific percentage of your death benefit to each beneficiary, including charities. You can also name a charity as a secondary or contingent beneficiary, who will receive the benefit if your primary beneficiary is unable to accept it.

Tax Implications:

It is important to note that there are generally no federal or state tax benefits associated with naming a charity as your life insurance beneficiary. You also cannot write off your premium payments as a tax deduction. However, if a charity owns your policy and you pay the premiums, you may be able to claim a charitable deduction.

Alternative Options:

If you wish to explore other options for charitable giving through your life insurance, you can consider adding a charitable giving rider to your policy. These riders allow you to donate an additional amount to a charity without reducing the death benefit for your beneficiaries. Another option is to put your policy in a trust, which gives you more control over how the money is spent. You can also donate your permanent life insurance policy to a charity while you are still alive, allowing them to surrender the policy for its cash value or continue the policy by accepting your premium payments.

Seeking Professional Advice:

It is always recommended to consult a financial professional or estate planning attorney when making decisions about your life insurance policy and estate planning. They can guide you through the process and ensure your wishes are carried out accurately and efficiently.

How to split proceeds: per stirpes or per capita

When it comes to splitting proceeds, you can choose to do so per stirpes or per capita. These are Latin terms that refer to two different ways of distributing life insurance proceeds. While both are methods for leaving the children in your life the cash from your life insurance policy, they work very differently.

Per stirpes means "by branch" or "by root" and is used to divide proceeds by branch of the family. In this case, a deceased beneficiary's share of an inheritance is passed along to their next of kin, usually the deceased heir's children. Surviving spouses are not included in a per stirpes distribution.

Per capita means "by the heads" or "by headcount" and is used to divide proceeds by the number of individuals. This method results in the remaining shares being distributed more equally among surviving descendants.

Consider the following example: Karen has two adult children, John and Molly, named as beneficiaries on her life insurance policy. John has three children, and Molly has one. If John dies before his mother Karen, under per stirpes, half the money would go to John's three children, and the other half to Molly. Under per capita, the money would be divided equally among John's three children and his sister Molly, with each receiving 25%.

It's important to note that neither per stirpes nor per capita is inherently better. The decision to choose one over the other should be guided by the testator's feelings for their family dynamic.

Frequently asked questions