Life Insurance: Choosing Your Beneficiaries Wisely

Choosing a life insurance beneficiary is an important decision that requires careful consideration. A life insurance beneficiary is the person or entity designated to receive the death benefit from a life insurance policy upon the insured's death. While it is not mandatory to name a beneficiary, it is essential to do so if you want a specific person or entity to receive the funds in the event of a payout. There are two main types of beneficiaries: primary beneficiaries, who are first in line to receive the death benefit, and contingent beneficiaries, who receive the payout if the primary beneficiary is unable to. It is also possible to have multiple beneficiaries by placing the policy under a trust or including it in a will. When selecting a life insurance beneficiary, it is crucial to consider various factors, such as the beneficiary's relationship to you, their financial dependence, and any potential legal or tax implications. Additionally, it is important to regularly review and update your beneficiary choices to align with any significant life changes.

Naming a spouse or child

Naming a spouse or partner as a beneficiary in your life insurance policy is a common choice. This is because, in the event of your death, your spouse can continue managing your household finances and set money aside for your child's future. If you both pass away, the trust can take over.

You can also name your spouse as a revocable beneficiary, which means that you can change the beneficiary without notifying the previous one. However, in some cases, your right to change a beneficiary may be limited by a divorce decree or settlement agreement. If you are divorced, you may still be able to change your beneficiary even if the beneficiary is “irrevocable”. On the other hand, you may not be allowed to change your beneficiary or you may be required to name a divorced spouse or child as an irrevocable beneficiary. Therefore, it is important to check with your insurance company or a lawyer before changing a beneficiary or taking out a new life insurance policy.

When it comes to naming your child as a beneficiary, it is important to note that minors cannot be paid the death benefit directly due to legal restrictions. Thus, it is recommended to name an adult beneficiary or set up a trust for your child. A trust can be used to fund your child's needs and ensure they receive the benefit promptly without having to pay taxes or legal fees.

In some states, children who are minors can have life insurance policies, but they can only list certain people, such as parents, grandparents, or siblings, as beneficiaries. Additionally, the child's parents or legal guardians must sign the child's application for life insurance. It is important to ask the insurance company for specific details regarding minor beneficiaries.

Selecting a trust

A trust is a legal entity that allows a third party (a trustee) to hold and manage assets for the benefit of one or more beneficiaries. A life insurance trust is created when an individual transfers ownership of their life insurance policy to a trust. The trustee then manages the benefits, distributing them according to the terms of the trust document.

There are two main types of trust: irrevocable and revocable. Irrevocable trusts cannot be changed or terminated once they are in place, whereas revocable trusts can be modified or cancelled. For example, a revocable trust can be useful for parents who want to set up guardrails for their children, so they don't spend their entire inheritance at once. However, irrevocable trusts can be beneficial for those with substantial wealth as they may allow them to remove tax liabilities.

When setting up a life insurance trust, it is important to consider the pros and cons of each type of trust and how they apply to your estate. It is recommended that you consult an attorney who specialises in trusts, such as an estate planning attorney, to help you navigate this process. They can guide you through the steps, including choosing a trustee. For complex estates, a bank or other financial institution may be assigned as a trustee, whereas for a simpler estate, a family member or other trustworthy individual can be chosen to oversee the trust and distribution of its funds.

It is also important to consider the type of life insurance policy you will use to fund the trust. Permanent life insurance policies are generally better for funding trusts than term life insurance, as there is a risk the term could end before the insured person dies, leaving the trust unfunded. When funding a trust with a new life insurance policy, you will need to decide how much life insurance you require and can afford.

Choosing a charity

• Naming a charity as the beneficiary of your life insurance policy: This is the simplest way to provide a charity with the death benefit proceeds from a policy. You can name multiple beneficiaries and specify what percentage of the death benefit should go to each. For example, you can give 100% to charity, or 80% to your family and 20% to charity, or any other combination. You can also name a charity as a secondary beneficiary, also known as a contingent beneficiary, which means that if your primary beneficiaries can't accept the death benefit, the charity would receive your insurance payout.
• Gifting a life insurance policy: You can donate your life insurance policy to a charity while retaining ownership of your policy, or you can transfer ownership of the policy to the desired organisation. The policy's death benefit will go to the charity once you've passed away if it's named as the beneficiary. The main drawback of this option is that the charity won't receive the benefit until you pass away, and you or the charity will need to continue making premium payments if the policy isn't yet paid in full.
• Adding a charitable giving rider: A charitable giving rider is an additional feature you can purchase to customise your life insurance policy. It pays out an additional amount to the charity of your choice when you die, without detracting from the death benefit to your other beneficiaries. Some insurers may include the rider at no additional cost, but this depends on the company and there may be limitations on the maximum allowable gift amount.
• Using policy dividends as regular gifts: You can use any dividends from your policy as regular gifts to the charity of your choice.

It's important to note that there is no federal or state tax benefit for naming a charity as your life insurance beneficiary, and you can't write off your premium payments as a tax deductions. However, gifting a life insurance policy can reduce your taxable estate, which can save money in estate taxes for upper-income taxpayers.

Adding beneficiaries later

You can also choose both a primary and a contingent beneficiary (and more than one of each). Naming a contingent beneficiary may be a good idea in case something happens to you and your primary beneficiary at the same time, such as a car accident. In this case, the insurance company would know who to pay as a backup. You can also name a revocable beneficiary, which means you can change the beneficiary without notifying the previous one. However, if you name an irrevocable beneficiary, you will need their written consent to make any changes.

It is a good idea to discuss these things with your insurer and a tax advisor to ensure that all aspects of the policy are fully understood. You may also want to consider placing your life insurance policy under trust to ensure the proceeds are paid to the right people. This can also help to avoid probate court, which can delay the payout and cost your estate money.

Reviewing and updating

It is important to review and update your life insurance beneficiaries to ensure your wishes are up-to-date and the right people are protected. You should consider doing this annually and when you experience major life changes, such as getting married, having children, or getting divorced.

When updating your beneficiaries, you can add or remove people from your list. You can also adjust the percentages of the payout that each beneficiary will receive. For example, you may want to reduce the percentage assigned to children who are no longer financially dependent on you and increase the percentage assigned to your spouse.

If you have a new spouse, you may want to add them as a beneficiary. If you get divorced, you may want to remove your ex-spouse from the policy and add a child, trust, or close family member instead. You can also add beneficiaries when a new child or grandchild joins the family.

If you have young children, you may want to set up a trust as the beneficiary of your life insurance policy. This allows you to designate a trustee to manage the trust funds for the care of your children until they are old enough to receive the funds directly. Once your children are over 18, you can alter your policy and name them directly as beneficiaries.

To add or remove beneficiaries, contact your insurer and request a "change of beneficiary" form, which you can then fill out and return by email or post.

Frequently asked questions