The biggest reason to buy life insurance is because you want to do the right thing and leave those who depend on your protected instead of burdened with crushing financial debt. So naming a beneficiary for your life insurance policy is one of the biggest, most important decisions you’ll ever make. Since you won’t be around to correct any goofs about who gets what and how it is distributed, you really do need to get it right the first time. To be avoided at all costs is any kind of legal complication that makes life difficult for your beneficiaries.
Two Types of Beneficiaries
According to MassMutual.com, beneficiaries come in two types: primary and contingent. Your primary beneficiary gets the policy payout as long as he or she outlives you, otherwise, goes to contingent or secondary beneficiary. MassMutual notes that “It is often desirable to have several levels of contingent beneficiaries.” This is this lets you put conditions on who gets what and is especially useful in instances where the primary’s benefits are being paid out over time instead of as lump sum.
You also have the option of identifying your beneficiary by name or relationship (Jane or my wife Jane) or by class designation. If you opt for that second choice take care to be very specific. For example, don’t just say “my children,” spell out whether you mean your natural children, your adopted children or your children by your third wife only.
Revocable and Irrevocable Beneficiaries
If you designate a revocable beneficiary, you can change that any time you want while you’re alive. While you can also change an irrevocable designation, you only do it with the consent of that beneficiary. In a perfect world, that wouldn’t create a problem. But the world you live includes divorces, ungrateful children, disappointing relationships and other messy family matters. Unless you have a compelling reason to do otherwise, opt for revocable.
Uncle Sam and Your Beneficiaries
Unlike real estate, cash, stocks and other stuff you might will to someone, the death benefits from your life insurance policy are generally tax-free. According to TheLawDictionary.com, “In most cases, life insurance benefits are exempt from state and federal taxation…on virtual all forms of traditional life insurance.” That source points out, however, that different laws may apply for pre-death payouts such as redeeming the cash value of a whole life policy. There are some other exceptions to this general rule, so if you want to be certain, talk to a tax expert.
How can you mess this up? Let us count the ways. First and foremost, naming a minor child as your primary beneficiary is a very bad idea because life insurance companies will not pay death benefits to a minor. Unless you’ve created a trust or some other arrangement to handle this, the courts will appoint a legal guardian (ka-ching), and your child won’t see the money until age 18 or 21, depending on the state.
While you can leave your death benefits to anybody, if you live in a community property state like California or Texas, you’ll need your spouse’s signature on a waiver before you can name anybody but him or her as a beneficiary.
Another common pitfall is to assume that your will overrides your life insurance policy. Not so. If change to your will affect the payout of your death benefit, be sure to contact your life insurance carrier so the change is reflected on your policy.
Finally, as much fun as it may be to imagine the surprise when a second cousin trice removed learns you’ve name her as beneficiary, resist the urge. Let your beneficiaries know while you’re alive that you’ve included them.