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Choosing your life insurance beneficiaries is as important as deciding what type of life insurance to buy and the amount of coverage that's necessary. Deciding on one or more life insurance beneficiaries often depends on your goals, your loved ones' needs and more. Here are tips for making important decisions about who will receive your life insurance benefit.
What Is a Life Insurance Beneficiary?
Life insurance can provide you with peace of mind knowing that your loved ones will be financially secure in the event of your death. A life insurance beneficiary is a person or entity that receives all or part of your life insurance policy's payout when you die.
The basic premise of life insurance is that you make monthly payments towards a life insurance policy so that if you pass away while the policy is in good standing, a payment (known as the death benefit) will be made to those you name as the beneficiaries. Your beneficiaries can be one or multiple people, a nonprofit or charity, the trustee of a trust you've established or your estate.
What to Consider When Choosing a Life Insurance Beneficiary
Before deciding who to name as your beneficiaries, it's important to be clear about your goals for the money, and to identify beneficiaries who are willing and capable of implementing them. To that end, here are some questions to consider when you're deciding who to name:
Who Do You Want to Help?
If you're the sole or primary earner in your household, a cash payout will help ease your loved ones' ability to cope with your death, deal with funeral expenses and secure their financial futures.
That can mean many things to different families. For a parent, it could mean funding college expenses for two preteen children and paying off the mortgage on the family home. For a married person without children, it could mean maintaining care for an aging parent or providing retirement income for a surviving spouse.
If you're single, or you're confident that your family would remain financially secure without your insurance benefit, you might feel that your money could be best used by a charitable organization whose mission you want to support.
Who Can Help Accomplish Your Goals?
There may be no one better equipped to fulfill your wishes than a surviving spouse or partner who shares your vision, but there are some cases when naming a spouse as beneficiary might not be the best idea.
- For spouses with anxiety over financial matters, deciding how to manage a cash inheritance could just add stress to an already difficult emotional time. Designating a trusted friend, family member or advisor to use the payout for the spouse's benefit could be a better choice.
Note that in community property states, a surviving spouse may be entitled to a share of any life insurance benefit even if they are not a designated beneficiary. This is only the case if policy premiums are paid using marital funds; if the policy is paid for by an employer, the beneficiary designation is recognized over the spousal entitlement. Community property states are Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin; Alaska and Tennessee laws allow couples to choose whether their assets are considered community property.
- If safeguarding a family business is the best way to provide continuing income for your family, naming the company or a partner as beneficiary might be most appropriate.
How Does Your Insurance Benefit Align With Your Estate Plan?
A key advantage of a life insurance benefit is that it can make funds available relatively quickly. Other parts of your estate, such as real estate or other investments, may need to await legal approval or will simply take time to sell.
If your estate is diverse and complex, or you don't think your heirs will need cash urgently, it may make more sense to fold your insurance benefit in with other financial bequests through a living trust. In such a case, you'd name the trust as your life insurance beneficiary, and include instructions for dividing your assets among your heirs.
Once you have a clear picture of where you want your life insurance benefit to go and who can best manage that process, here are some other factors to consider before designating your beneficiaries:
- Avoid naming minors as beneficiaries. Taking care of children and grandchildren is a common goal of estate planning, but minors are forbidden by law from directly receiving inheritances in many jurisdictions. If a minor is named as a life insurance beneficiary, a court assigns a trustee to manage the inheritance. This process can take months to set up and can be subject to fees that will deplete your gift. Instead, set up a living trust that ensures the life insurance payout will be smoothly managed and distributed by the trustee.
- Decide whether beneficiaries are revocable or irrevocable. Beneficiaries on most life insurance policies are "revocable," which means you can change them anytime. It's possible, however, to name "irrevocable" beneficiaries, which means they can't be removed from the policy unless they agree to it. Irrevocable beneficiaries are sometimes used on policies taken out by business partners, for use in maintaining operations or replacing someone central to a company's operations. They are also sometimes required in divorce proceedings to protect a former spouse's finances.
- Choose secondary beneficiaries carefully. Life insurance policies often require you to name secondary beneficiaries to receive the benefit if the primary beneficiary has died or cannot be located upon your death. The same considerations that guide your choice of primary beneficiaries should apply to your naming of secondary ones.
- Change your beneficiaries when circumstances change. If you've designated revocable beneficiaries, make sure to update your policy when circumstances change. You can update your policy if, for instance, a named beneficiary dies or becomes incapacitated, minor children reach adulthood or your business or marital relationships end.
- Keep your will in sync with your insurance policies. A life insurance policy always pays named beneficiaries, so if your will includes instructions assigning your life insurance benefit to anyone else, those instructions won't be honored.
If you want your insurance benefit to be folded in with your other assets for distribution to your heirs, the wisest course may be to establish a trust and make that the policy's beneficiary. In that case the trustee will ensure your wishes are carried out. It's possible but ill-advised to name your estate as a beneficiary, as it could be subject to probate taxes and made available to creditors.
Other Estate Planning Tools
A well-designed life insurance policy can be a great help to a grieving family facing funeral expenses and financial uncertainty, but ideally it's only one element of your estate plan. Creating your plan could include the following actions:
- Make a will. The heart of any estate plan is a will—a document that spells out who should receive your assets when you die. Having a will is important even if you have few heirs and your estate is simple, because if you die intestate—with no will, or with one a court deems invalid—the court will decide how your estate is distributed.
- Set up a living will. This is a document that provides instructions for your own medical care in the event you are incapacitated. Elements vary somewhat from state to state, but a living will can provide instructions for organ donation or end-of-life care, and can also name someone to make medical decisions on your behalf.
- Consider charitable gifts. You may want to leave a gift to a charity, educational institution, house of worship or other organization you support. This can be done by naming the organization as a life insurance beneficiary or by leaving appropriate instructions in your will.
When setting up life insurance and making other estate planning decisions, be sure to consult with professional advisors familiar with the laws in your state, as some policies may vary.
The Bottom Line
End-of-life issues such as life insurance may not be fun to contemplate, but spelling out your wishes can spare your loved ones from legal entanglements and provide them with a secure financial future. If you need a bit more support, a financial advisor or estate planner can help you identify the best types of insurance to meet your goals.