While the concept of a life insurance beneficiary is simple, a number of situations and scenarios could create confusion and threaten the policy owner's wishes. Understanding the different types of beneficiaries and how to properly designate each one will ensure your beneficiaries get exactly what you had planned.
The primary beneficiary of a life insurance policy is the owner's first choice of recipient. If the insured person dies, all policy proceeds get distributed to the primary beneficiary. You are free to designate as many primary beneficiaries as you choose, as well as stipulate the percentage of the death benefit to which each is entitled.
A contingent beneficiary represents a life insurance policy owner's second choice to receive the death benefit. Contingent beneficiaries will only be paid if all named primary beneficiaries are dead or unwilling to receive the payout. No restrictions or limitations exist regarding the number of contingent beneficiaries a policy owner may designate.
Many life insurance companies allow policy owners to list a "per stirpes" election for any or all beneficiaries. A per stirpes designation indicates the owner's desire to have that particular beneficiary's share of the death benefit made payable to his heirs if he predeceases the policy owner. For example, if you name your son as a beneficiary, he predeceases you, and his three children were his heirs, they would each take a third of your son's share of the proceeds. This is a method often used to ensure policy proceeds are kept within the intended family.
Policies Without Beneficiaries
If a life insurance policy owner dies without having named any primary or contingent beneficiaries, the death benefit becomes part of the decedent's estate and may be subject to probate and estate taxes. This might result in a sizable reduction in how much money passes to heirs. Since life insurance proceeds are usually received income tax-free, it is always wise for policy owners to maintain accurate and current beneficiary designations.
Revocable Vs. Irrevocable Beneficiaries
Most life insurance beneficiaries are revocable, meaning the policy owner is free to add, remove or otherwise change the list of recipients and the amounts to which each is entitled. Irrevocable beneficiaries, once designated, cannot be changed except with written authorization from that particular beneficiary. Naming an irrevocable beneficiary ensures that money will be distributed in the manner and amount desired by the policy owner.
Minor Children as Beneficiaries
Significant complications may arise if you list minor children as beneficiaries to your life insurance policy. Insurance companies cannot pay proceeds to an underage beneficiary, and will instead turn the money over to the courts, who will typically establish a simple trust for the benefit of each child and choose a trustee to manage the money. When the children reach age 18, they will be granted unrestricted access to those funds. If handing over potentially large sums of money to your young adult children is not your intention, and you would prefer a measure of control over who would act on their behalf with respect to the money, further estate planning is necessary.
Gregory Gambone is senior vice president of a small New Jersey insurance brokerage. His expertise is insurance and employee benefits. He has been writing since 1997. Gambone released his first book, "Financial Planning Basics," in 2007 and continues to work on his next industry publication. He earned a Bachelor of Science in psychology from Fairleigh Dickinson University.