Understanding the Named Beneficiary of a Life Insurance Policy
Who should you name as your life insurance beneficiary?
Sometimes it is an easy question to answer whom you should name as your life insurance beneficiary – like your spouse. Other times the answer is not so straight forward. You have to remember that a named beneficiary of a life insurance policy is entitled to the death benefit claim (their percentage portion of it) if you die, and there is little or no recourse for other family members or creditors to have a claim on that money. So, the named beneficiary of a life insurance policy is a powerful legal designation for benefits, and should be chosen carefully.
You will also need to update your beneficiary information if your situation changes, like death of a spouse, birth of a child, divorce, remarriage, wanting to give to charity or grand-children, etc. Keeping on top of your named beneficiary designation is not difficult, and changes can easily be made by the policy owner with simple forms (need wet signatures for life insurance contracts). So, let’s take a closer look at how to designate a beneficiary(s) on your life insurance policy.
Primary and Contingent Beneficiaries
Your life insurance contract comes with a primary and a contingent beneficiary designation section. The most common mistake is that people assign one person to the primary beneficiary and then a second person to the contingent beneficiary, but their intention was these two people would share the death claim when it is paid out.
The Primary Beneficiary section of your contract is for all named beneficiaries (more than one can be designated) who are first in line to receive benefits. If, for instance, you wanted to name two adult children as your primary beneficiaries, each getting 50% of the death claim, you would add them both in under the primary beneficiary section.
The Contingent Beneficiary section are those people who are second in line to receive benefits, only if the primary beneficiary(s) has pre-deceased the insured person (died before the person on the life insurance contract dies). Because life insurance policies are very long-term financial products, things can happen along the way. If you named your spouse as the primary beneficiary and he/she dies before you, then benefits will flow to the contingent beneficiary(s) automatically. Without designating a contingent beneficiary, your death claim will flow to your estate if the primary beneficiary has already died.
If you want to make sure your life insurance benefit goes to your family, and avoids taxes, probate and creditors of your estate, make sure you name a contingent beneficiary(s) along with your primary beneficiary(s).
As described above, you can designate multiple people in each beneficiary section (primary or contingent). For example, the policy owner has 3 adult children and no spouse to leave the money to; he/she can designate all three children as primary beneficiaries. He/she can assign all equal amounts of the death claim, or break it up into different portions.
For example, let’s say a widow has 3 adult children and she is leaving them the money. One of her children is a single mother with a couple of kids and she is struggling financially. The widow decides to give 50% of her life insurance policy to her daughter who is a single mom, and 25% to each of the other children, who are much more secure financially. When the widow dies, the life insurance policy will be divided up accordingly.
What happens if one of the beneficiaries dies before the life insurance is paid out? When there are multiple beneficiaries it is best to complete a new beneficiary designation form to make sure the division of the claim is done according to your wishes. If the death claim is to be split up equally between all beneficiaries, this will flow through accordingly – i.e. with three beneficiaries they would each get 33.3% of the claim, but if one dies, the remaining two would each get 50%. When the death claim is not split equally, it must be redone to indicate how much the remaining beneficiaries are entitled to, or the excess could flow downwards to the contingent beneficiaries.
If you name a minor as your beneficiary (either primary or contingent) and a death claim is to be paid out to them, the life insurance company cannot pay money to a minor. A minor in Canada is anyone who is under the age of 18. This is where a Trustee would come in (see next section below). Without a Trustee assigned, the life insurance company would hold onto the money until the minor child reaches age of majority and then give them their portion of the money from the life insurance claim.
It might not be the best idea to name minor children as beneficiaries, since they will be entitled to the money as soon as they are 18. Some 18 year olds are responsible with large sums of money, but many are not. One way to control how your children will receive the money is to pay it into your estate, and let the death benefit proceeds fund a trust set up through your Will for the ongoing benefit of your children while they finish their education and get established in life.
Assigning a Trustee
If you do have minor beneficiaries designated you should also chose a trustee. A trustee should be someone you trust with the loving care of your children and will use the money for their ongoing care, education and living expenses. The trustee will have access to the funds to be used for the benefit of minor children.
Again, when the child reaches 18, their portion of the life insurance benefit, minus what the trustee has spent for the child’s care, is paid out to them. If the trustee has used the funds inappropriately, it will be the responsibility of the now adult child to pursue legal action against the trustee to recoup wasted money. This is not something you want your children to go through, so choose the trustee wisely.
Naming your Estate as the Beneficiary
In some cases it is wise to choose the Estate as the beneficiary. Life insurance money can be paid into the estate tax free, and then be controlled through your wishes spelled out in the Will. This is how you can make sure young adults get only enough money to pay for post-secondary education, for instance, and then have the remainder paid out at a later age when they are more financially responsible.
There is one major draw-back to having life insurance money flow into the estate. Once the money lands in the estate, it can be accessed by creditors who your estate might owe money to. Also, the funds are up for dispute if your will is challenged by other family members who think they have a claim on a portion of your estate. These funds would also increase the amount paid out in probate, executor and legal fees, thus shrinking the total amount of life insurance proceeds left over for those you want to give the money to. If you think your estate could be complex and get tied up in court, maybe you should leave the money as a named beneficiary designation. If your estate is easily processed, then it might be wise to control the funds through your Will, which is more versatile than the beneficiary designation on your life insurance policy.
Life Guard Insurance can help set up your life insurance with well thought-out beneficiary designations
It is important to discuss who and how the life insurance money is paid to when applying for life insurance. Even though you can easily change your beneficiary designations later on, many people just forget about this and don’t update things, leaving holes in their life insurance plans. Talk to one of our qualified life insurance brokers to make sure you set up your beneficiary(s) properly on your life insurance policy(s).
The article was written by +Mitch Reynolds. If you found this article interesting or it made you think, please feel free to share your comments below. Liking us on Facebook, giving us a +1 on Google or Tweeting this article about naming your life insurance beneficiary would be very much appreciated.