Understanding Life Insurance: Successor Beneficiaries Explained

When you take out life insurance, you name one or more beneficiaries who will receive a payout when you pass away. However, if your named beneficiary cannot collect the payment, it's important to have a successor beneficiary in place. A successor beneficiary is a substitute who can receive your insurance benefits if your primary beneficiary is unable to. This could be because the primary beneficiary has died, but it could also be because they cannot be located, they are ineligible, or they decline the payment. By naming a successor beneficiary, you can ensure that your assets are distributed according to your wishes and avoid the need for probate.

Who can be a successor beneficiary?

A successor beneficiary is a beneficiary-of-a-beneficiary. In other words, when the primary beneficiary dies after the assets have already been inherited, the individuals named on the inherited owner's beneficiary designation form become the successor beneficiaries.

A successor beneficiary can be anyone, such as a spouse, child, sibling, or even a non-person such as a charity, estate, or trust. The successor beneficiary will inherit the assets if the primary beneficiary is unable to accept them due to death, incapacitation, or other reasons.

For example, if a person designates their spouse as the primary beneficiary and their sibling as the successor beneficiary, the sibling will only receive the death benefit if the spouse and the policyholder die at the same time, such as in a car accident. If the spouse survives, they will receive the proceeds and the sibling will have no claim.

It is important to designate both primary and successor beneficiaries to ensure assets are distributed according to one's wishes and to avoid probate, which can be time-consuming and expensive.

What happens if there is no successor beneficiary?

If there is no successor beneficiary, the payout will go to the insured's estate. This means that the payout will be subject to estate taxes and claims by creditors. The insured's heirs may receive less than the original death benefit and it will take longer for them to receive it.

To avoid this, it is recommended that the policyholder regularly reviews and updates their primary and secondary beneficiaries. This ensures that the death benefit is passed on according to the policyholder's wishes.

If there is no clear chain of payment, the benefit will typically revert to the insured's estate. This can happen in several ways. For example, if there is no named primary beneficiary, the insurance company will distribute the payment to the estate. It will also happen if the policy does not have a legitimate beneficiary or if the secondary beneficiary is not legitimately established.

In the case that the primary beneficiary is incapacitated and there is no secondary beneficiary, the benefits will also revert to the estate. This can complicate matters, as the death benefit will be subject to probate.

What are the tax implications of being a successor beneficiary?

A successor beneficiary is an individual designated to receive the death benefit of a life insurance policy if the primary beneficiary dies before the insured. The primary beneficiary retains the right to the proceeds of the policy as long as they are alive. If the primary beneficiary passes away after receiving the death benefit, the funds are transferred to their estate, not to the successor beneficiary.

Now, what are the tax implications of being a successor beneficiary?

In the context of retirement accounts, a successor beneficiary is bound by the SECURE Act's 10-year distribution rule. This means that the successor beneficiary must receive or empty the remaining balance of the retirement account within 10 years of the previous beneficiary's death, regardless of their relationship to the original account owner or their physical condition. This is due to the Tax Code's "at least as rapidly" rule. If the original beneficiary was using the 10-year distribution rule, the successor beneficiary can only continue the existing distribution period.

For example, if the original beneficiary of a traditional IRA was taking annual stretch required minimum distributions (RMDs) based on their own life expectancy, and they pass away, the successor beneficiary must continue taking RMDs for the remaining years within the 10-year period based on the original beneficiary's distribution schedule.

It's important to note that once required minimum distributions are 'turned on', they cannot be later 'turned off' by a successor beneficiary. This means that if the original beneficiary started taking RMDs, the successor beneficiary cannot stop those distributions, even if they qualify as an eligible designated beneficiary due to disability or chronic illness.

To summarise, the tax implications for a successor beneficiary of a retirement account include being subject to the SECURE Act's 10-year distribution rule and the Tax Code's "at least as rapidly" rule, which may result in a shorter distribution period than if they had been the original beneficiary. Seeking professional advice can help individuals navigate these complex tax rules effectively.

What is the difference between a contingent and a successor beneficiary?

A beneficiary is any person who gains an advantage or profits from something. In the financial world, a beneficiary typically refers to someone eligible to receive distributions from a trust, will, or life insurance policy.

A primary beneficiary is the first in line to receive assets upon someone's death. They are either named a beneficiary in the person's will or, if there is no will, they are first to inherit based on intestacy laws.

A successor beneficiary is the individual designated to receive the death benefit of a life insurance policy if the primary beneficiary predeceases the insured. However, as long as the primary beneficiary is alive, they retain the right to the proceeds of the policy. If the primary beneficiary dies after receiving the death benefit, the funds are transferred to their estate, not to the successor beneficiary.

A contingent beneficiary is the backup beneficiary. They only receive assets if the primary beneficiary is unable or unwilling to do so. A contingent beneficiary in fact "moves up" to the role of primary beneficiary when the original primary beneficiary either dies or disclaims all or part of the assets.

A successor beneficiary emerges after an account has already been inherited by the primary beneficiary. In other words, upon claiming the account of the deceased, a primary beneficiary is advised to name their own beneficiary to receive their inherited assets after their death. When the primary beneficiary dies, the entities they named as beneficiaries of the inherited account are considered successor beneficiaries to the inherited retirement account.

How do I choose a successor beneficiary?

A successor beneficiary is a substitute who can receive your insurance benefits if your primary beneficiary cannot. While death is the most common reason for a primary beneficiary not receiving a payout, there are other reasons this might happen, such as the primary beneficiary being incapacitated, or unable to be located.

When choosing a successor beneficiary, it's important to consider the possibility that your primary beneficiary might not be able to accept the benefits. To avoid the need for probate, it's a good idea to name at least one successor beneficiary. This can be a wise precaution to ensure your assets are distributed as you wish.

If you are married, you might designate your spouse as the primary beneficiary, and your children or other family members as successor beneficiaries. If you have children, you may name them as primary beneficiaries, and specify that their children (your grandchildren) will receive their interest if they die before you. If you have no children, you may name your parents or siblings as primary beneficiaries, and name successors in case they die before you.

In all cases, it's important to be clear about the chain of payment to avoid any payments reverting to your estate.

Frequently asked questions