Choosing a Life Insurance Beneficiary

By WHN's Guest Columnist, M. Bryan Freeman

If you own assets, from bank accounts to life insurance, it’s important that you choose a beneficiary. A beneficiary is the person or entity who receives your assets or the proceeds of your assets (like the “death benefit” from your life insurance) after you die.

Choosing a beneficiary

Choosing a beneficiary means that the proceeds from your life insurance will be directed by you and the funds will go to whom or to what you wish.

If you do not choose a beneficiary, the funds will go directly into your estate or may go directly to someone to whom you did not intend to leave your life insurance proceeds which may be determined by your state’s laws.

Types of beneficiaries

  1. Person or entity. A beneficiary can be a person or an entity. A husband or wife is a common beneficiary designation but you may also designate a non-spousal/non-legal partner, a former spouse or another loved one as a beneficiary.
  2. WHN TIP: Former Spouses

    Your life insurance company may have special requirements if you designate certain beneficiaries. For instance, if you designate a former spouse as your beneficiary, they may request you complete a form demonstrating your former spouse’s “non-spouse” status.
  3. Children. You can name minor children as beneficiaries, but would then also need to designate an adult custodian or trustee. Naming a custodian may be as simple as filling out a custodian designation form from your life insurance company. Designating a trustee would entail setting up a legal trust through an attorney.
  4. Your estate. Naming your estate as beneficiary can give you flexibility, since you can always change your will to designate who gets what, but you also have to consider that having a death benefit paid to your estate increases your estate’s value, which can have tax liability and other implications.
  5. Charity or nonprofit organizations. You can name a favorite non-profit or charity organization as your beneficiary. You may do this to create certain tax or financial planning advantages; such choices should be discussed with your advisors (attorney, accountant, financial planner, etc.).

WHN TIP: Restrictions

Your life insurance company may have guidelines about whom or what can be named as a beneficiary or how you go about doing that. Or, they may at least ask for further information or documentation about your designation.

Things to consider when choosing a beneficiary

A beneficiary is a very personal choice and will depend on your personal and financial circumstances.

Some people see death benefits as protection for their loved ones; some people see death benefits more as a financial transaction – a transfer of wealth. Consider whether there are people who depend on you for financial support.

  • Would any people who depend on you for support be able to manage the death benefits themselves? (For instance, are they minors, mentally competent, etc.?)
  • Are there people who will bear expenses in the event of your death?
  • Are there financial or personal considerations for wanting to ensure your death benefits are passed directly or indirectly to certain people or entities or institutions?

It is important in some instances to be very specific. For instance, naming your spouse rather than putting “spouse” or “husband” as your designated beneficiary; the risk is that an ex-spouse might receive the death benefit unintentionally, as an example.

Also, if you name each of your children as beneficiaries but have a subsequent child, that child would not be included in the distribution because he or she is not named as an actual beneficiary unless you update your documents.

Making it official

To formally elect your beneficiary, you will have to formally notify your life insurance company or you may elect a beneficiary when you apply for or modify your life insurance.

You should to notify your beneficiary that he or she has been chosen for such; you may want to provide them documentation of such.

WHN TIP: Keep It Up to Date

You should consider discussing your beneficiary designation with your advisor at annual reviews in the event there has been a change in your beneficiary decision due to their health, welfare or personal problems.

Changing and Updating Beneficiaries

  1. Most life insurance policies will allow you to change your beneficiary at any time. The forms and procedures through which you make changes will vary from insurer to insurer.
  2. It is a good idea to review insurance, financial and estate planning needs regularly, perhaps annually, especially as you make major life changes, such as marriage, divorce, the birth of a child, a child becoming an adult, and so on.
    • In the event your named beneficiary is your son or daughter and they have divorced, their divorce decree may state the former spouse is entitled to a portion of future assets. It may be wise to consider your beneficiaries’ circumstances (when updating your estate and beneficiary information).
  3. Other changes in your life do not automatically change your beneficiary. For instance, if you name your spouse as a beneficiary and then you divorce, the beneficiary designation does not change simply because you legally divorced. Your spouse will still be your designated beneficiary and you will have to separately and formally change that, if you wish and if you are allowed to do so by the terms of your divorce and the resulting settlement.
  4. It is possible to name an “irrevocable beneficiary;” in general, this means that, while that person is living, you cannot change the beneficiary designation without his or her consent. Consult with your advisors on this issue.
  5. In the event you no longer have a need or cannot afford the insurance you own and consider a life settlement, if your beneficiary is irrevocable, there may be a problem with consummating the deal.

Is this covered by my will?

Naming a beneficiary for your life insurance is separate from your will and other estate-related documents. In fact, naming a beneficiary on a life policy (or other asset) can mean it is paid directly to your beneficiary and does not have to pass through your estate. So, even if there is a problem with your will or estate, the asset for which a beneficiary is named separately may be settled prior to other aspects of your estate.

In consultation with your advisors (attorney, etc.), you may or may not want to mention your life policy and its beneficiary in your will and other documents.

What are the tax consequences?

In general, the beneficiary is responsible for any taxes owed on the death benefit they receive. Depending on the ownership of the policy, the proceeds could possibly trigger the estate tax even though the life insurance is tax free to the beneficiary.

If you leave your life insurance proceeds to your estate, the death benefit is counted toward the value of your estate and may affect the tax liability. Conversely, if you designate a beneficiary directly on the policy and the death benefit does not pass through your estate, the value of the death benefit does not affect the tax liability of your estate.

What if I don’t name a beneficiary?

If you do not choose a beneficiary, the funds will go directly into your estate or may go directly to someone to whom you did not intend to leave your life insurance proceeds. For instance, if you do not choose a beneficiary, your state’s laws may determine who receives your life insurance proceeds.

It’s important that you thoughtfully choose a beneficiary for each asset you own, especially your life insurance. Make such a designation after learning about the process and your options, and only after conferring with advisors, like your insurance agent or attorney. With good information and sound advice, you can make the best decision for your individual circumstances.

M. Bryan Freeman, a licensed insurance agent for 29 years, is founder and president of Habersham Funding LLC, an Atlanta-based life settlement provider that does business nationally.

The information provided here is not meant to be a substitute for professional insurance or legal advice. Always check with a financial, legal, tax, or other advisor before making any insurance policy decisions or changes.