The first question to ask after determining you need life insurance is not, “Which type of life insurance is best for me?” or “How much life insurance do I need?” These questions can wait until you’ve answered an even more fundamental question: “Who should I designate as my life insurance policy’s beneficiary?”
Or, put another way: “Who am I doing this for?”
There’s more to this question than you might think because it has many possible answers. You can designate as your life insurance policy’s beneficiary virtually any individual, business entity, or trust. You can designate contingent beneficiaries, who’ll receive part or all of the policy’s death benefit if the primary beneficiary dies before you. You’re also free to add and remove beneficiaries as long as your policy remains in force.
What to Know About Life Insurance Beneficiaries
Your beneficiary designations reflect the policy’s purpose — whether that’s replacing income lost due to your premature death, ensuring your kids can pay their way through college without excessive student loan debt, protecting your business partner’s financial interest in a shared enterprise, or a combination of purposes.
Before you choose beneficiaries, understand who and what is eligible, succession rules for life insurance beneficiaries, what happens when your beneficiary designations conflict with your will, and possible adverse consequences for certain beneficiaries.
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To make an informed beneficiary designation, familiarize yourself with eligibility rules for primary and contingent beneficiaries, the designation process itself, and the rules and exceptions governing beneficiary payouts.
In principle, any person or legal entity is an eligible life insurance beneficiary. That includes:
- U.S. citizen or permanent resident members of your immediate family
- U.S. citizen or permanent resident relatives outside your immediate family
- Foreign national family members living inside or outside the United States
- A business partner
- A business entity in which you have an ownership interest
- A charitable organization or nonprofit you’ve supported in the past
- A trust created for the benefit of surviving family members, pets, charitable causes, or any other person or entity
In practice, the most common life insurance beneficiaries are the insured party’s spouse and adult children. The insured party’s spouse is the default beneficiary in nine states that have mandatory community property laws for married couples:
- New Mexico
If you live in a mandatory community property state and apply for a life insurance policy while married, you must name your spouse as the policy’s primary beneficiary unless they consent to a different beneficiary. In Alaska and Tennessee, community property requirements are optional. If you live in either state and choose to opt into the requirements with your spouse, this rule also applies to you. It never applies to policies written before your marriage date.
Primary and Contingent Beneficiaries
Your policy’s primary beneficiary is first in line to receive its death benefit. You can designate multiple primary beneficiaries to receive equal or unequal shares of the death benefit — for instance, 33.3% each to three adult children or 75% to your only adult child and 25% to a younger sibling. The shares must add up to 100%.
Under normal circumstances, each primary beneficiary has an equal claim (seniority) to their share of the death benefit. No one can override their claim, regardless of its size.
That’s not the case for contingent beneficiaries, also known as secondary beneficiaries. They have no right to any portion of the death benefit unless all of the primary beneficiaries predecease the policyholder, disclaim their shares, cannot be located by the insurer, or are otherwise deemed ineligible to receive the death benefit. When a policy names multiple contingent beneficiaries, each has equal claim to their respective shares, the sum of which must be 100%.
If a beneficiary dies while the policy remains in effect, the death benefit is reallocated among the remaining beneficiaries with equal seniority. For example, when one of two primary beneficiaries dies with the policy still in effect, the sole remaining primary beneficiary receives the entire death benefit and the contingent beneficiaries receive nothing.
Adding and Changing Life Insurance Beneficiaries
While the precise procedure for policy owners to add or change life insurance beneficiaries varies by insurer, the basic process is the same. These stipulations apply to both term life insurance and whole life insurance policies.
All life insurance applications ask policyholders-to-be to name at least one beneficiary. You can name as many primary and contingent beneficiaries as you’d like before your policy is officially written, subject to community property laws.
Provide as much information as possible about each beneficiary: full legal name and aliases, current address, date of birth, Social Security number or Taxpayer ID number (if they have one), and any other details requested by the insurer. For non-U.S. persons or entities, ask your insurer whether additional information is required. Because many years might elapse between your policy’s effective date and your death, it’s vital you provide enough detail to locate beneficiaries who’ve moved or changed their names.
Revocable or Irrevocable?
Your beneficiary designations can be revocable or irrevocable. You’re allowed to remove revocable beneficiaries at your sole discretion, but irrevocable beneficiaries must consent to removal — and, in certain states, to any substantive changes to the policy, such as death benefit amount. Because irrevocable beneficiary designations can have unwanted consequences, such as an ex-spouse retaining sole claim to the death benefit after divorce, revocable beneficiaries are more common.
As long as your life insurance policy is effective, you should review your beneficiary designations following major life events involving you or any of your named beneficiaries. Common events that could impact your beneficiary designations and result in a beneficiary change include:
- You get married
- You divorce your spouse
- Your spouse dies
- You welcome a dependent child, minor ward, or adult dependent with special needs into your family
- Any of your named beneficiaries dies or ceases to operate (in the case of a business or charity)
- Any of your named beneficiaries becomes incapacitated
- You become estranged from any of your named beneficiaries
Even if these events don’t occur, you should still review your beneficiary designations every few years to confirm everything remains as you intend. For example, if the unemployed adult child you designated as a co-beneficiary finds long-term, living-wage employment and no longer needs your financial support, they may no longer warrant co-beneficiary status.
Rules for Payouts to Beneficiaries
A life insurance policy is a binding contract between the insurance company and the policyholder, who is usually also the insured party. The insurance company’s reputation depends on its making good on the promise to pay death benefits to named beneficiaries. Absent a clear breach of contract by the policyholder, the company is overwhelmingly likely to do just that.
That said, it’s not guaranteed. An insurer or state insurance regulator could deny part or all of a policy’s death benefits to named beneficiaries in these situations:
- Suicide. Most life insurance policies include a “suicide clause,” which denies death benefits to beneficiaries if the policyholder dies by suicide early in a policy’s term (usually the first two years).
- Murder. When the circumstances of a policyholder’s death are suspicious, the insurer is likely to withhold death benefits pending the results of the investigation. If there’s reason to believe a beneficiary is responsible for the policyholder’s death, the insurer could refuse payment altogether.
- Dishonesty. Policyholders who omit or obfuscate details likely to affect their insurability or premiums could jeopardize their beneficiaries’ payouts. Common examples include lying about tobacco use, known health conditions, or dangerous hobbies.
- Insurable Interest. Your insurer won’t ask you to prove on your policy application that your premature death represents a financial threat to your named beneficiaries. However, a beneficiary with no clear “insurable interest” in the policy — that is, a financial stake in your continued existence — could pose a problem after your death. That’s especially likely when the policyholder and insured party are different people or entities, as happens when investors pay older individuals upfront to take out insurance policies on their lives. In many cases, the insurer will honor the contract in the absence of a clear insurable interest, but the insured party’s next of kin may have standing to sue the policyholder. If you’re concerned about this scenario arising, consult an attorney familiar with your state’s insurance regulations.
Who to Designate As Your Beneficiary
Designating a life insurance beneficiary or series of beneficiaries is a personal matter. Before you finalize your decision, consider the policy’s purpose, the relationships between possible beneficiaries, and the potential of unintended consequences for certain beneficiaries.
Primary and Contingent Beneficiary Considerations
Most life insurance applicants designate individual beneficiaries on the basis of biological or legal relation (or both). Here’s how that looks for applicants who are:
- Married With No Children. The primary beneficiary is the policyholder’s spouse. Contingent beneficiaries could include living parents or former legal guardians, siblings, or cousins.
- Married With Minor Children. The primary beneficiary is the policyholder’s spouse. Contingent beneficiaries could include a trust set up to provide for the children, plus any living parents, siblings, or cousins.
- Married With Adult Children. The primary beneficiary is the policyholder’s spouse. Depending on the age and competence of the adult children, contingent beneficiaries could include a trust for the children, plus any living parents, siblings, or cousins. Consult an estate planning attorney to determine an appropriate age cutoff for the trust. Many recommend controlling adult heirs’ inheritances until well past the age of majority, perhaps to age 25 or 30.
- Divorced or Single With No Children. The primary beneficiaries could include a long-term domestic partner (if applicable) or close living relations, such as parents, siblings, or cousins.
- Divorced or Single With Children. The primary beneficiaries could include a trust set up to provide for the children, the children themselves (if competent adults), a long-term domestic partner, and/or the former spouse (if they have partial or sole custody of minor children).
- Partners in a Business Enterprise. The primary beneficiary is the policyholder’s business partner or partners. This type of life insurance policy is known as key person insurance. It usually complements a separate policy held for the benefit of the policyholder’s family and defined by one of the five scenarios above.
Rather than designate primary and secondary beneficiaries without clear insured interests, or who might otherwise raise eyebrows at the insurance company, consider naming a trust as beneficiary instead. As long as the trust’s guiding documents are clear on how its assets are to be disbursed, this is a more efficient way to deal with situations such as:
- Giving death benefits to charitable organizations
- Providing for pets after your death
- Providing for romantic partners with whom you’re not married or in a legal domestic partnership
- Circumventing a new spouse’s claim in favor of a child from a previous marriage that ended in death or divorce
- Circumventing relatives’ claims in favor of someone to whom you’re not related (such as a close friend)
Trusts aren’t foolproof. Jilted heirs can and do challenge trusts, and depending on the laws in your state, yours could have standing to do so for several years after your death. To minimize the likelihood of a bitter, protracted legal battle, consult an estate planning attorney before taking out a life insurance policy or setting up the trust you’d like to designate as its beneficiary.
Rules for Life Insurance Policies With No Beneficiaries
If all of your primary and contingent beneficiaries predecease you and you fail to add new beneficiaries before your death, your policy’s death benefit will default to your estate. Eventually, the proceeds will pass to your heirs, but not before months of delay and the deduction of executor expenses.
If you die intestate (without a will), then the probate court overseeing your estate will have to decide how to allocate your estate’s assets, lengthening the process and raising its cost. You can avoid this mess by creating and updating a will through Trust & Will and making sure your policy always has at least one living beneficiary.
Conflicts Between Your Life Insurance Policies and Your Will
Your life insurance policy’s death benefit doesn’t have to go to your estate. Indeed, one of the key benefits of life insurance is the fact that its proceeds are usually disbursed rapidly and without probate court involvement. When a conflict arises between the terms of your life insurance policy and the stipulations of your will, the life insurance policy takes precedence.
Therefore, it’s usually safe for your will to remain silent on your life insurance policy’s death benefit. Your life insurance contract shouldn’t intersect with the probate process under normal circumstances.
Possible Adverse Consequences for Your Beneficiaries
Most of the time, life insurance beneficiaries receive death benefits enthusiastically and without reserve. But not always. A life insurance windfall could cause financial or legal problems for beneficiaries who:
- Receive Certain Types of Government Benefits. Even though it’s not taxable under normal circumstances, death benefit income could render beneficiaries ineligible for Social Security disability payments and certain other government programs upon which they rely for income or care.
- Are Legally Competent But Financially Immature. If you’re concerned a beneficiary might blow their windfall on frivolities, designate a trust instead.
- Are Parties to Contracts Where the Policyholder and Insured Are Two Different Entities or Individuals. The policy’s death benefit could be taxable when the policyholder, insured, and beneficiary are three different individuals or entities. A common example: One spouse (the policyholder) takes out life insurance on the other (the insured) and designates an adult child as the beneficiary. When the insured party dies, the adult child may be liable for federal income taxes.
- Are Foreign Nationals. Foreign nationals’ home countries could tax life insurance benefits. Consult a local tax attorney for guidance.
These issues don’t have to ruin your beneficiary designation plans, but they do warrant special attention and perhaps a sit-down conversation with an estate planning attorney.
More often than not, a life insurance policy is a visible and valuable token of the policyholder’s commitment to care for and protect their loved ones in perpetuity. That commitment might manifest in the replacement of lost income, guaranteed payment for higher education expenses, or enough cash to ensure long-term financial security in retirement.
But it doesn’t have to do any of those things. Because virtually any individual or entity is eligible for designation as a life insurance beneficiary, many policies aren’t set up for the benefit of the policyholder’s relatives. Instead, they provide vital support for charitable organizations, compensation to business partners threatened by the loss of the policyholder’s talent, or tangible tokens of appreciation for close friends of policyholders estranged from living family members.
Unless you live in a community property state, no one can tell you who to designate as your life insurance policy’s primary or contingent beneficiary. Which means no one can interfere with your freedom to do what you believe to be right with your life insurance proceeds.