Updated October 22, 2019

Life Insurance Beneficiary: What You Need to Know

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What's a life insurance beneficiary? And who should be yours? Read this before buying a life insurance policy.

Naming a life insurance beneficiary is a relatively straightforward process. But a number of legal, financial, and tax-related issues can occur if you don't do it properly.

Understanding who (and how) to choose, life insurance rules, and mistakes to avoid can make a big difference in how quickly your beneficiary receives the death benefit. In this guide, we cover:

What Is a Beneficiary?

A beneficiary is who, or, in some cases, what, will receive the payout of your life insurance policy when you die.

This payout, or death benefit, can be used to pay:

  • Funeral or other end-of-life expenses
  • Future care of family and loved ones
  • Student loans or other outstanding debts

There is more than one type of beneficiary.

Primary Beneficiary
You can name one person, multiple people, or even an organization, like a nonprofit, as your beneficiary.

You could also put the money in a trust for children who are not yet of age or who you want to receive the payout at a later date.

Contingent Beneficiary
This is a person (or people) who will receive the death benefit if your primary beneficiary cannot.

For Example: If you name your spouse as your beneficiary and your parent as the contingent beneficiary, your parent would receive the death benefit IF you and your spouse both die at the same time.

Who Should You Name as Beneficiary?

Deciding who should get the death benefit if you pass away isn't easy. A good rule of thumb is to choose the person (or people) who will be most financially impacted by your death.

Here are several scenarios that may apply to your situation:

Married with Kids
Your spouse or partner is a good choice as beneficiary when you have children. If an ex-spouse will be the guardian of your children should you die, you might consider leaving them a portion of the benefit with specific instructions for that sum.

Married with No Kids
You'll still likely want to name your spouse as the beneficiary here. Or you could name any family members you financially support, your parents, a close friend, or perhaps a sibling.

Single Parent
In this case, you could name your child or children as long as they are not minors. (We cover reasons to avoid this in a later section.) You could also set up a trust that the child can access at a certain age.

If you have multiple children and are naming each as a beneficiary, be sure to specifically designate who gets how much.

For example, you could split the benefit evenly between two children. Or perhaps you have one child in college and one with children, so you want the one with children to receive 60% and the one in college to receive 40%.

Another option is your parent or other trusted family member or guardian. In this case, be sure to include specifications for use of the benefit.

People Actively Involved in Raising Your Children
Regardless of your marital status, you probably know who will take care of your children if you die unexpectedly.

Consider designating that person/people as a beneficiary. Your death benefit can go towards expenses like childcare, clothing, tuition, etc. This will help ease the financial burden of raising the children.

Single No Kids
You may consider naming a parent or close family member. Provide instructions for what the benefit should go to, like paying for funeral expenses or other end-of-life costs, or outstanding debts.

You can also consider naming a charity as beneficiary (more on that below).

People with Outstanding Loan Debt
If you have student, auto, or other personal loans in which you had a co-signer, you may want to designate a portion of your death benefit to assist that person in paying off any remaining debts.

Update your life insurance policy when you get married or have children. This may include changing your original beneficiary to reflect those life changes.

Other Options

Charity Organizations
They can serve as a beneficiary, too. You'll want to clearly outline:

  1. The specific organization

  2. Address/contact information of a branch or location (if applicable)

  3. Instructions for how the money should be allocated

Estates
Your estate is everything you own, including your car, home, bank accounts, investments, and personal possessions.

If you name your estate as a beneficiary, the proceeds of your life insurance will go to the executor, or administrator, of your estate. That person is designated in your last will and testament and must be approved by probate court.

If you do not have a will, you cannot name your estate as your life insurance beneficiary.

They can then use your life insurance to pay any debts and taxes you owe after your death. An estate also helps prevent your family from having to sell your assets to raise quick cash to pay bills.

One downside to naming your estate is the death benefit may be taxed. Discuss this option with your insurance agent or accountant before finalizing the decision.

Make sure to tell the person you choose as the beneficiary. An honest conversation can clear up any questions about your intentions for the benefit they will receive.

If you have multiple beneficiaries, this dialogue will allow you to clarify your decisions and avoid any hurt feelings or confusion after you're gone.

How to Name a Beneficiary

You will be asked to choose a beneficiary when you purchase the policy. But you can also update the information later online.

When naming your beneficiary, include as much information as possible. It helps the insurance company find and contact the beneficiaries you've named.

For each beneficiary include their:

  • Full name
  • Social Security number
  • Date of birth
  • Relationship to you
  • Amount or percentage of the death benefit they should receive
  • Any conditions of when, how they get the death benefit, or what it can be used for
  • Phone number/contact information

Your life insurance agent can help update your policy if you need to change your beneficiary. This might happen when you get married, have a child(ren), or something happens with a previously-named beneficiary (a divorce, for example).

Distributing Between Beneficiaries

When naming multiple beneficiaries to your policy, you have choices as to how you designate the way the death benefit is dispersed.

Per Stirpes
This means you designate the beneficiaries by family lineage. The benefit would be distributed first to those closest in lineage to you, then passed down and divided equally among the remaining relations.

For example, say you designate your two children as beneficiaries. One child dies before you do.

If you die next, 50% of the death benefit would go towards your remaining child and the other 50% would go to your deceased child's surviving children or family members.

Per Capita
This means the proceeds are divided equally among all of the beneficiary survivors of the lineage line.

For example, let's say you have two children and one passes away before you. That deceased child has three children, and the surviving one has none.

Your insurance death benefit would be divided equally between each of your grandchildren and your surviving child. In other words, each person would receive 25% of the benefit.

To avoid confusion, you also need to consider a percentage of the benefit versus a specific dollar amount. This is particularly significant if you have a Whole or Universal policy that can grow in value over time.

For example, say you have a $100,000 Whole life policy and designate $50,000 to each of your two children.

When you pass away, the policy has grown by $15,000. If you designated a specific dollar amount rather than percentage, the insurance company won't know what to do with the remaining $15,000. This may lead to legal challenges.

Typically, with these types of insurance, you are better served designating each child 50% instead of a set dollar amount.

What Happens to Life Insurance with No Beneficiary?

There are two "non-beneficiary" scenarios:

  1. No Beneficiary Listed
  2. No Beneficiary Available

No Beneficiary Listed
In some cases, a beneficiary may not be named. Some people leave off a name expecting to outlive the policy. Others intentionally leave off a beneficiary so the payout goes only towards funeral costs, final bills, and outstanding debts.

The results of not having a beneficiary named vary from state to state. Some states will designate the dollars to the insured's estate, while others will designate to next of kin.

No Beneficiary Available
If the original beneficiary passes away before the policyholder AND no contingent beneficiary is named, the funds may be designated directly to the next of kin.

For the death benefit to go to a next of kin, that person must be a close blood relation of the insured. Typically this is a child, sibling, or parent.

The funds may also be forfeited to the estate of the insured, and then used to pay off old debt and other expenses.

If the beneficiary is named as the estate, the money cannot be touched by anyone except the executor of the estate. This may work for you if you want to avoid any hard feelings or drama between beneficiaries and other family members.

Life Insurance Beneficiary Taxes

Life insurance proceeds received by a beneficiary typically aren't includable in gross income. In other words, the beneficiary WON'T report them as taxable income on your federal tax return.

In a few instances, however, the benefit would be taxed. As the policyholder, you should be aware of these scenarios to avoid them all or inform the beneficiary ahead of time.

Always consult with a financial advisor or insurance agent to determine the best way to avoid having a death benefit be taxed.

  1. You elect to have the insurance company distribute the payment at a later time or in installments.

    You may opt to do this if your child is a minor or if you only want them to have a certain dollar amount at one time. But when a final death payout is made, that amount may now include interest earned.

    While the death benefit payout is not taxable, the interest is. The beneficiary would have to report the percentage of interest as taxable income.

  2. You have "incidents of ownership" in the policy.

    This happens if you cancel your policy, surrender it, borrow against it, or in some states, change the beneficiary. If any of these scenarios occurred in the three years before your death and a beneficiary inherits the policy, the death benefit will be taxed.

  3. You manage a life insurance policy for someone else and list a third person as a beneficiary.

    For example, if you manage a life insurance policy for your spouse and name your child the beneficiary, the policy as a "gift" to your child. In this case, you could be taxed if the payout total is more than federally-defined limits.

Read more about the IRS tax limits at IRS.gov.

You should also consider the scenario if placing the benefit into a trust.

Beneficiary Rules for Spouses

Just because you are married doesn't mean your spouse is entitled to your policy. Though laws vary by state, "what's mine is yours" doesn't always apply unless your spouse is named as your beneficiary.

It's important to name your spouse as the primary beneficiary so they can receive the death benefit when you pass away.

Make sure to update your policy if you get divorced and/or re-married. If your ex-spouse remains the beneficiary, legal battles and payout delays may occur.

Some states DO dictate that both spouses have shared and equal rights to assets earned during a marriage. In this case, benefits from a life insurance policy would be split 50/50—half would go to the surviving spouse, and the rest divided with any named beneficiary.

These states include:

  • Arizona
  • California
  • Idaho
  • Louisiana
  • Nevada
  • New Mexico
  • Texas
  • Washington
  • Wisconsin

Common Life Insurance Mistakes

These mistakes can cause confusion, complications, or tax or other legal issues for you or your beneficiary.

  1. Having a minor as the beneficiary: Your policy payout may be used to cover the expenses of raising children. But having a minor as your beneficiary is NOT a good idea.

    Most life insurance providers will not pay a death benefit to someone underage. If you do not have a trust or have not arranged for a legal guardian to receive the payout, you will be appointed one by the court. This can cause delays and other unnecessary legal ramifications.

  2. Being vague when naming a beneficiary: For example, don't name the beneficiary as "children" or "spouse." You should include as much information as possible about the people or organizations who will receive your payout.

  3. Forgetting to specify beneficiary conditions: if you have more than one beneficiary, be detailed when describing who gets which percentage of the policy.

    And make sure to include clear instructions if you want the payout to go towards something specific, like paying for college tuition or a wedding.

  4. Have a separate policy owner, named insured, and beneficiary on ONE policy: The death benefit is likely subject to taxation if you are the owner of a life insurance policy on someone else's policy and list a third person as a beneficiary. The owner of the policy and person insured should be the same person.

  5. Forget to inform beneficiaries: This will avoid any surprises, confusion, or hard feelings. This allows the beneficiary to better understand what they are receiving and what it should be used for. Especially when you have specific contingencies, your beneficiary would rather hear the instructions from you than a lawyer after you're gone.

  6. Not updating your policy when you update your will: Just because someone is listed in your will as a recipient of your life insurance doesn't mean they will receive the payout. They also need to be listed as the beneficiary on your policy.

    The names on the life insurance policy are the people who receive the payout. Avoid confusion and legal battles by ensuring everything matches.

  7. Not updating your policy if your life changes: If you get married, divorced, or have children, make sure you update your policy to reflect those changes. This is especially pertinent if a previously-named beneficiary should no longer be listed, or if you have to add children or a spouse to receive the payout.

    You should also regularly update the contact information of the beneficiaries so there is no delay in getting them the payout.

  8. Forget to see if beneficiary is getting government assistance: If your beneficiary is receiving some type of government assistance for having a low income, your life insurance payout might put them above the threshold, which means they risk losing that aid.

    This is also applicable if you have a special needs child. By naming him or her as the beneficiary, they may no longer be eligible for assistance. Instead, you should designate a guardian or special needs trust fund as the beneficiary.

How Payouts Work

Your beneficiary should file a claim as soon as possible after your death. They will have to call your insurance company to inform them.

Three documents are needed to claim a policy's death benefit:

  • Death Certificate: This proof of death ensures the policies are being legally and legitimately claimed.

  • Policy Document: This document has all of the information about the policy, including the benefit amount, policyholder details, etc. This will be used to ensure you are making a claim on the correct policy.

  • Claim Form: This gets filled out with policyholder and beneficiary information, including how you would like to be paid.

The insurance company will then process your claim, verify you are the beneficiary, and check policy information (to ensure the premiums are up to date or there are no policy lapses). This could take 30 to 60 days.

Once the claim is processed, they will pass the payout to the beneficiary in the way requested, or they will notify the beneficiary of a delayed or denied claim.

Keep a physical or digital copy of your policy somewhere or with someone who will be able to reference it after you die. This could be your life insurance agent, in a locked safe, or perhaps with your primary beneficiary.

You should also give your beneficiary the contact information of your life insurance agent and company.

Reasons for Denied Claims

While it doesn't happen often, a life insurance company may deny a claim, therefore not paying the death benefit to the beneficiary. These instances are:

Contestability Period
Most life insurance policies have a "contestability period," or a two-year time period after the life insurance policy goes into effect. That allows the insurer to make sure information provided to them during the application process was accurate.

This period protects the company from fraud and misrepresentation. For example, if you tell the insurance company you are in good health, then die from cancer six months later, the company will contest the claim to ensure you didn't lie on your application.

Even if you pass away after the two-year time period, the insurance company still has a right to investigate for insurance fraud if the death circumstances are questionable.

Suicide
Many policies have clauses stating if the policyholder dies by suicide within the first two years of the policy, the death benefit will not be paid out.

Homicide
If the policyholder is murdered, the insurance company will not pay the death benefit until the beneficiary has been cleared of any wrongdoing.

An Employer's Failure to Submit a Waiver of Premium
If you receive life insurance through your employer, you are enrolled in a group life insurance plan. Your employer's HR department is often the mediator between the life insurance company and insured employees.

Sometimes the employer isn't forthright about eligibility requirements. A deceased worker may unwittingly not meet these requirements and their claim will be denied.

Other times, the employer may fail to submit the necessary documents to the insurance company, so coverage is terminated.

Lapse in Coverage/Nonpayment of Premiums
If the policyholder was behind on premiums or allowed their policy to lapse, the death benefit claim will be denied.

The beneficiary has the right to know whether the insurance company sent premium-due notices to the correct address and if they clearly warned the insured of the impending lapse.

Receiving the Death Benefit

As a beneficiary, you can choose how to receive the death benefit. These depend on the insurer and plan, but there are a couple of common ways.

Lump Sum
With this type of payment, you will receive the death benefit all at once. This ensures you have enough to pay for funeral and other end-of-life costs upfront. You won't pay taxes on the benefit.

You can choose to have it directly deposited into your bank account or sometimes receive a check.

Annuity
With this financial option, the money is invested and then paid out as an annual payment for a predetermined number of years.

Because this is an investment option, the annuity payments could be considerably higher than the original death benefit. However, if you die before receiving all of the payments, your beneficiary may collect less.

Bottom Line

When you purchase a policy, whether it's term, whole, or universal, you must name a beneficiary. This ensures your death benefit goes to a person or organization you designate, avoiding legal challenges and unnecessary taxes on the payout.

When you have life changes like getting married, divorced, or having children, it's critical to talk to your life insurance agent or insurance company to update your policy and beneficiaries.

Know your options to make the most informed decision and name the right beneficiary.

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