Life Insurance Allocation: Strategies For Effective Coverage

Life insurance is a crucial financial decision that ensures your loved ones are provided for after your death. While the decision to purchase life insurance is important, it is equally vital to allocate it appropriately. The primary purpose of life insurance is to offer financial security to your beneficiaries, who are usually family members or friends. However, it can also be an organisation, such as a charity or a family trust. When allocating life insurance, it is essential to consider your financial obligations and choose beneficiaries who will assume these responsibilities in your absence. The allocation of proceeds can be adjusted according to your preferences, with the option to include primary and contingent beneficiaries. It is also important to regularly review and update your life insurance allocation to reflect any changes in your life circumstances.

Understanding primary and contingent beneficiaries

When setting up a life insurance policy, it's important to understand the difference between primary and contingent beneficiaries. These are the people or entities who will benefit from your policy when you pass away.

Primary Beneficiaries

The primary beneficiary is the person or entity who is first in line to receive the death benefit when the insured dies. They are typically someone very close to the insured, such as a spouse or dependent. The primary beneficiary will collect the death benefit if the insured passes away while the plan is still active.

Contingent Beneficiaries

A contingent beneficiary is a backup beneficiary who will receive the death benefit if the primary beneficiary is unable to. This could be because the primary beneficiary has died, cannot be found, or refuses the payout. The contingent beneficiary is second in line to collect the payout and is typically someone who is less closely related to the insured than the primary beneficiary, such as a child or other family member.

Multiple Beneficiaries

It is possible to name multiple primary and/or contingent beneficiaries, and to set a percentage or amount of the payout for each to receive. For example, a married couple with no children may each decide to buy life insurance, naming each other as the primary beneficiary on their respective policies. If that same couple later has children, they may name them as contingent beneficiaries.

Updating Beneficiaries

It is important to review and update beneficiaries regularly, especially after major life events such as marriage, divorce, or the death of a loved one. By reviewing beneficiaries regularly, the policyholder can help ensure a smooth payout process after their passing.

How to allocate among multiple beneficiaries

When allocating life insurance among multiple beneficiaries, it is important to understand the different types of beneficiaries and the rules surrounding them.

Primary and Contingent Beneficiaries

The two basic types of beneficiaries are primary and contingent beneficiaries. Primary beneficiaries are the first in line to receive the life insurance proceeds when the insured passes away. Contingent beneficiaries, also known as secondary beneficiaries, will only receive the benefit if the primary beneficiary dies before the policyholder or is otherwise unable to accept the benefit.

Per Stirpes and Per Capita

When allocating among multiple primary beneficiaries, you can choose between two distribution methods: per stirpes and per capita. Per stirpes means that the proceeds are divided by rank in the family, while per capita means that the proceeds are divided equally among all beneficiaries. For example, if you have two primary beneficiaries and choose per stirpes, each will receive 50% of the benefit. However, if one of them passes away, their share will be divided equally among their heirs. On the other hand, if you choose per capita and one of the primary beneficiaries passes away, their share will be split equally between the remaining beneficiaries.

Revocable and Irrevocable Beneficiaries

Another important distinction is between revocable and irrevocable beneficiaries. Revocable beneficiaries can be changed at any time without their consent, offering flexibility if your circumstances change. In contrast, irrevocable beneficiaries cannot be changed without their approval, providing certainty that the benefit will reach a specific person.

Allocation Percentages

When allocating among multiple beneficiaries, you are free to choose the percentages each will receive, as long as they add up to 100% in total. For example, you may allocate 50% to your spouse, 25% to one child, and 25% to another child.

Updating Beneficiaries

Life insurance policies allow you to update your beneficiaries at any time to reflect changes in your life, such as marriage, divorce, or the birth of children. It is important to review your policy regularly and make any necessary updates to ensure it aligns with your current wishes.

Communicating with Beneficiaries

While not required, it is generally a good idea to communicate your beneficiary designations to your loved ones. This can help prevent confusion and potential conflicts in the future and ensure they are aware of your wishes.

The importance of keeping beneficiaries updated

Life insurance is a way to ensure that your loved ones are financially protected after you pass away. However, simply purchasing a life insurance policy is not enough. It is crucial to regularly review and update the beneficiaries listed on your policy to ensure that your wishes are carried out and that your loved ones receive the benefits you intended for them.

Avoiding Unintended Consequences

If you do not keep your beneficiaries updated, your money could end up in the wrong hands or not reach everyone you want it to. For example, if you get divorced and forget to remove your ex-spouse as a beneficiary, they could still receive the benefits upon your death. Similarly, if you have more children after initially purchasing the policy, they will not be included as beneficiaries unless you update your policy.

Preventing Delays in Payouts

Keeping your beneficiaries updated can also help prevent delays in payouts. If there is no named beneficiary, the death benefit will typically go to the policyholder's estate and will have to go through the probate process, which can take several months or even years. By contrast, naming a beneficiary allows the benefit to be paid directly to that person or entity, bypassing probate and ensuring a faster payout.

Reflecting Your Current Wishes

As your life changes, your relationships may evolve, and your wishes for how your life insurance benefits should be distributed may change as well. Reviewing your beneficiaries periodically allows you to make sure that your policy reflects your current wishes and circumstances. This can help you avoid unintentionally disinheriting someone or leaving out new family members who you may now want to include as beneficiaries.

Avoiding Legal Complications

Outdated beneficiary information can also lead to legal complications. If the death benefit is paid to an unintended recipient, it could result in legal challenges or family conflict. Keeping your beneficiaries updated helps ensure that the benefit is paid to the correct person or entity, reducing the risk of legal issues.

In conclusion, keeping your life insurance beneficiaries updated is essential to ensure that your wishes are carried out, your loved ones receive the benefits you intended, and any payouts are made in a timely manner. Review your policy regularly and make updates as needed, especially after significant life changes such as marriage, divorce, the birth of a child, or the death of a beneficiary.

How to choose a beneficiary: an individual vs an organisation

When choosing a beneficiary for your life insurance policy, you can select either an individual or an organisation. A beneficiary is the person or entity that will receive the death benefit payout after your passing.

Choosing an individual beneficiary

If you choose to name an individual as your beneficiary, this will usually be your spouse, children, or other family members. You can also name multiple individuals as beneficiaries, and allocate what percentage of the payout each will receive. For example, you might give 50% to your spouse, 30% to your child, and 20% to a local charity.

If you have young children, you should be aware that minors cannot receive the death benefit directly. In this case, you can either appoint a guardian to administer the funds, or set up a trust for the money to go into until your child becomes an adult.

Choosing an organisational beneficiary

Alternatively, you can name an organisation as your beneficiary. This could be a charitable organisation or a family trust. Many people choose to name charities they feel passionately about as beneficiaries, as a way of leaving a legacy.

Primary vs. contingent beneficiaries

It's important to name both a primary and a contingent beneficiary. A primary beneficiary is the first in line to receive the death benefit, and a contingent beneficiary is a backup who will receive the benefit if the primary beneficiary dies or cannot be found.

Irrevocable vs. revocable beneficiaries

A revocable beneficiary can be changed at any time, but an irrevocable beneficiary designation cannot be changed without the beneficiary's approval. Irrevocable designations are useful if you want to ensure that a specific person, such as your child, receives the benefit.

The process of changing a beneficiary

Changing the beneficiary on your life insurance policy is a straightforward process, but it's important to remember to do it. It's a good idea to review your beneficiary information at least once a year and after any major life events, such as marriage, divorce, or the birth of a child.

To change your beneficiary, simply contact your insurance company and submit a change of beneficiary form. This can usually be done online, on paper, or over the phone. You will need to provide personal information about your new beneficiary, such as their full legal name, relationship to you, and Social Security number.

You can also specify how you want the death benefit to be split among beneficiaries and whether someone is a primary or contingent beneficiary. A primary beneficiary is the person first in line to receive the death benefit, typically a spouse or family member. A contingent beneficiary is a backup who will receive the benefit if the primary beneficiary is no longer alive.

It's important to note that only the policyholder can change the beneficiary, and this must be done while the policy is still active. After the policyholder's death, the beneficiary cannot be changed, and the proceeds will go to the designated beneficiaries.

In most cases, you are free to choose anyone as your beneficiary, including a person, charity, trust, or your estate. However, if you live in a community property state and bought your policy after getting married, you will need your spouse's permission to name someone other than them as the beneficiary. Additionally, if you have named an irrevocable beneficiary, you will need their approval to remove them from the policy.

Frequently asked questions