Your life insurance beneficiary is the person (or people) who will receive the payout from your life insurance policy. Typically it's a spouse or adult children. That sounds simple enough, but there ways to go wrong. Here are some potential pitfalls.
Naming a broad group rather than individuals: If you name a group like "children" there might be confusion later on and the life insurance money could go places you didn't intend. Did you mean to include step-children, children born outside of marriage, and so on?
Solution: It's best to list the full names of your beneficiaries.
Naming minor children: Minors can't receive a life insurance payout directly. If a minor child is named as a beneficiary, a probate court will appoint an estate guardian for the money -- probably not what you want to happen, and it could delay the money getting to the child. The child can receive the money directly when they are the "age of majority," which is usually 18 but varies in a few states. See a state list of ages of majority from the National Conference of State Legislatures.
Solutions: Instead, you can appoint a custodian yourself using the Uniform Transfer to Minors Act, or set up a living trust to receive and distribute the money. Consult an attorney on the best way to pass life insurance to children, based on your situation.
Here's more about the Uniform Transfer to Minors Act from the Social Security Administration.
Naming someone with a disability and Social Security Income: If your beneficiary has a disability and is receiving Social Security Income (SSI) benefits, the life insurance payout could make them ineligible for further benefits. Generally one cannot have more than $2,000 in assets and receive SSI.
Solution: Set up a "special needs trust." Work with a lawyer to make sure the trust won't affect SSI eligibility. Funds from the trust can't be used for basics like food and shelter if someone is receiving SSI for a disability.
Here's more about SSI benefits from the Social Security Administration.
Naming someone other than a spouse in a community property state: In community-property states, naming someone who's not your spouse could cause a legal entanglement, That's because the wages you use during marriage to pay for the policy are also your spouse's "property." Community-property states are Alaska (optional, couples can opt in), Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin.
Solution: If you're naming someone else, get your spouse's consent in writing.
Failing to update beneficiaries as life changes: You may give little thought to your life insurance except to pay the bill on time. But life changes can affect who you want to name as a beneficiary. For example, if you divorce and remarry but still have your ex-wife listed as a beneficiary, she'll collect the money. That's because life insurance is a contract and insurers are obligated to execute the terms of the policy -- they can't make their own judgments about who "should" get the money.
Solution: Revisit your beneficiary list from time to time to make sure you have the right people named.
Life insurance beneficiaries in a divorce agreement
When there's alimony and/or child support required in a divorce agreement, the settlement might also stipulate that the person paying support have life insurance. In these cases, the beneficiary is the ex-spouse. The problem is that the ex with the life insurance could stop paying for it -- or change the beneficiary -- leaving the other with no source of support.
The ex-spouse who's the beneficiary should monitor the payment status on a regular basis. Have your name listed on a policy as someone who gets notified if premiums aren't paid. Even better is to be the owner of policy, with the ex as the insured person and the one who pays the premiums. As the policy owner, you control who's named as a beneficiary and are notified if the premiums aren't paid.
Types of beneficiaries
- Primary beneficiary: This is the person who will receive the life insurance benefit.
- Secondary beneficiary: The person who will receive the life insurance money only if the primary beneficiary dies before the insured person. If the primary beneficiary is alive, the secondary beneficiary receives no life insurance money.
What happens to life insurance if there's no beneficiary?
When you buy a policy you have to name a beneficiary. If that person dies before you, you end up with a policy with no living beneficiary.
If there's no life insurance beneficiary the insurer will follow the terms defined in the policy for the situation. Often that means the money will go to the insured's estate.
Per stirpes vs. per capita
It's best to keep your beneficiaries up to date. If you name someone who later dies, update your beneficiary list with the life insurance company so that the payout goes exactly where you want it to go.
There are two ways to designate who gets a life insurance payout if one or more of your named beneficiaries is deceased: per stirpes or per capita.
Per stirpes means that the beneficiary line will flow down a family tree until it reaches someone living. Let's say you named a son as a beneficiary but he is deceased. Then money would be divided among his children (your grandchildren by him); if they're deceased, it will be divided among their children (your great-grandchildren), and so on.
Example of per stirpes: Say you designate 50% to your son John and 50% to your daughter Mary. John is deceased at the time of your death, so 50% goes to Mary and the other 50% is divided equally among John's children.
Per capita means that if a beneficiary is deceased, the payout is divided equally among any living beneficiaries and the survivors of the deceased beneficiary.
Example of per capita: Say you designate 50% to your son John and 50% to your daughter Mary. John is now deceased but had two children. The payout would divided into three equal parts among Mary and John's two children.
Whoever you name as a life insurance beneficiary, tell them
As soon as you buy a policy, let your beneficiaries know. You want to avoid a situation where your life insurance payout doesn't get claimed because your family didn't know about it. Or a situation where they know there's a policy but don't know what company holds it.
The only piece of information beneficiaries need to start a claim is the name of the life insurance company. Once they initiate a claim, the life insurer will confirm they are listed as beneficiaries and send them the appropriate claim paperwork.