Understanding Life Insurance: Beneficiary Basics Explained

A life insurance beneficiary is a person or entity chosen by the policyholder to receive the death benefit from their life insurance policy when they pass away. The beneficiary can be a family member, friend, charitable organisation, or even a business. The policyholder can select more than one beneficiary and decide how much of the death benefit each one receives. While it is not mandatory to name a beneficiary, doing so ensures direct financial support for loved ones and prevents the benefit from becoming part of the estate, which can cause delays in the payout.

Who can be a beneficiary?

A beneficiary is the person or entity you select to receive the death benefit from your life insurance policy when you pass away. You can name anyone as a life insurance policy beneficiary. This can be a family member, a friend, or a child. Trusts, charitable organisations, and religious institutions can also be named as beneficiaries.

Some state laws may require you to name your spouse as your primary beneficiary, with them receiving at least 50% of the benefit. In some states, you may need documented permission from your spouse to name someone else as the primary beneficiary.

The key is that the beneficiary chosen must have an insurable interest in the life of the insured. In other words, they would experience financial challenges or hardship if you were to pass away.

If you name a minor child as a beneficiary, they won't be able to receive the life insurance payout directly. Instead, a trustee must be named to manage the funds until the child is of legal age.

You can choose more than one beneficiary and decide how much of the death benefit goes to each person.

What happens if you don't name a beneficiary?

Naming a beneficiary is not mandatory, but it is highly recommended. If you don't name a beneficiary, the death benefit from your life insurance policy will automatically become part of your "estate" (all the money, property, and belongings you leave behind). This means that the money will have to go through probate, a legal process that costs money and slows down how quickly the money gets to your loved ones. In some states, money paid to your estate can be claimed by creditors.

For retirement accounts like a 401(k), if you die without a beneficiary named, your assets will likely be held in probate, where a court will have to sort out your financial situation and determine how to distribute your assets.

Most life insurance policies have a default order of payment if you do not name a beneficiary. For many individual policies, the death benefit will be paid to the owner of the policy if they are different from the insured person and still alive, otherwise, it will be paid to the owner's estate. For group insurance policies, the order typically starts with your spouse, then your children, then your parents, and then your estate.

If there is no default order specified in your policy, the payout may be paid to your estate or held in probate. The probate process can be lengthy and complicated, and it may take years before your loved ones can access your assets. This delay can be avoided by designating beneficiaries.

Additionally, if you don't name a beneficiary, it may be unclear who is entitled to the funds, which can further delay the benefit payment.

What is a primary beneficiary?

A primary beneficiary is the first in line to receive benefits from a will, trust, retirement account, life insurance policy, or annuity upon the account holder's or grantor's death. An individual can name multiple primary beneficiaries and stipulate how distributions will be allocated. For example, a parent with a $100,000 life insurance policy can name their son and daughter as the primary beneficiaries, and decide to distribute the assets accordingly, such as $60,000 to the daughter and $40,000 to the son. Each can also receive equal 50% portions of $50,000 if the parent makes that clear in the insurance policy.

The primary beneficiary is different from a contingent beneficiary, who is second in line to receive benefits. The contingent beneficiary receives an inheritance if they outlive the primary beneficiary or if the primary beneficiary refuses the inheritance or cannot be located. Both primary and contingent beneficiaries must be legally competent to accept the gift.

It is important to note that named beneficiaries of insurance policies and accounts like 401(k)s and Individual Retirement Accounts (IRAs) take precedence over those designated in a will. This means that assets in these accounts will go to the named beneficiary, even if the will suggests otherwise. Therefore, it is crucial to regularly review and update primary beneficiaries to ensure they align with the individual's wishes.

When choosing a primary beneficiary, it is essential to consider the financial needs of loved ones and those who depend on the individual for financial support. Additionally, state laws or insurance carrier rules may restrict who can be named as a beneficiary. For example, a spouse may need to sign a waiver before someone else can be named as the beneficiary.

What is a contingent beneficiary?

A contingent beneficiary, also known as a secondary beneficiary, is a person or entity that serves as a backup to the primary beneficiaries named on a life insurance policy. When you pass away, if all your primary beneficiaries have also passed away, your contingent beneficiaries will receive the payout. You can name any person or organisation as a contingent beneficiary, and you may have one or several.

When purchasing life insurance, you will be asked to designate at least one primary beneficiary, and it is also recommended that you name at least one contingent beneficiary. While it may not be a requirement, having a contingent beneficiary ensures that someone you care about receives your death benefit in the event that your primary beneficiaries are no longer able to accept the payout.

In the absence of a primary beneficiary, the death benefit will be paid to the insured person's estate and will be subject to estate taxes and probate court. By designating a contingent beneficiary, you can help expedite the payout process and keep your benefit intact.

It is important to note that contingent beneficiaries only receive a payout if all primary beneficiaries are confirmed as deceased or are otherwise unable to accept the benefit. Therefore, they serve as a backup plan and are second in line to inherit your assets.

You can name multiple contingent beneficiaries and set a percentage or amount of the payout for each to receive. However, if you name minor children as beneficiaries, you may need to select a custodian to manage the payout funds until they reach legal age.

Contingent beneficiaries can be individuals such as children or other family members, or they can be organisations or charities that you value and believe are worthy of the funds.

How to choose a beneficiary?

Choosing a life insurance beneficiary is an important step in owning a life insurance policy. Here is a guide on how to choose a beneficiary:

Who can be a beneficiary?

Almost anyone can be a life insurance beneficiary, including people, organisations and trusts. Some common examples are:

• A person, like your spouse.
• Multiple people, like your children.
• A charitable organisation.
• A legal entity, like your company.

Primary vs. contingent beneficiary

Primary beneficiaries are the first in line to receive the life insurance death benefit if you die. Contingent beneficiaries, on the other hand, receive the death benefit if the primary beneficiary dies before you do. You can have multiple primary and contingent beneficiaries and decide how much of the payout each party receives.

Irrevocable vs. revocable beneficiaries

Irrevocable life insurance beneficiaries cannot be changed without the beneficiary's approval. They are useful if you want to ensure that the death benefit reaches a specific person, such as your child, or in a divorce agreement. In contrast, revocable beneficiaries can be changed, updated, added or removed at any time.

Factors to consider when choosing a beneficiary

Start by asking yourself why you have life insurance in the first place. Who relies on you financially and would need help paying ongoing bills or covering costs incurred by your death, such as funeral expenses? You can also leave money to a charity or a trust for your children.

Be as specific as possible when designating a beneficiary. Include identifying factors such as their full name, Social Security number, relationship to you, date of birth and address. Consult a legal professional to ensure you use the correct language.

Naming children as beneficiaries

If you want to name your children as beneficiaries, be aware that if they are minors, the payout can be complicated. You can either appoint a legal guardian to receive the payout on their behalf or set up a trust for them.

Naming your estate as your beneficiary

Although life insurance proceeds are typically not taxable, the payout may be subject to estate tax if left as part of a large inheritance. Your estate may also get held up in probate court, delaying the payout. Therefore, it is generally recommended to name a specific beneficiary on your life insurance policy.

Frequently asked questions