Life insurance is there to benefit your survivors, and it’s vital to decide which of those people should receive the proceeds of your policy after you die. The choice can help ensure the right family members receive the policy’s benefits, and quickly and simply.
Failing to choose a recipient, on the other hand, has the exact opposite effects. Life insurance that lacks a beneficiary when you die must go through the probate process. That could add “six months to a year” to the timing for the payout and “cost thousands of dollars in legal fees,” warns Joe Buhrmann, a financial planning consultant at eMoney Advisor. And the eventual beneficiary from that process may not be the person you might have wished.
Naming a life insurance beneficiary overrules the instructions in your will, says Sean Burke, vice president of Stuart Estate Planning Wealth Advisors in Coconut Creek, Fla. Without named beneficiaries, he explains, your insurance proceeds will be distributed like any other assets, as set out in the will. Absent a will, the death benefit will be given to your closest living relative. Those default assignments may not align with your wishes for your life insurance, Burke says.
We asked experts for tips on how to best ensure your death benefit reaches the people you want, and quickly, and how to manage your beneficiary designations along the way. Here’s their advice.
Pick the person who most relies on your income
As a rule, the proceeds from your policy should go to the person -- or people -- who will be most affected financially by your death, Buhrmann advises. "For example, a spouse and/or children have a financial interest in the life of the insured because they likely require income...to successfully run the household."
Consider adding more than one name to the policy. For one, experts say it’s wise to pick a secondary beneficiary -- someone who will receive the payout should the primary beneficiary pass away before the policy is updated. That way, you don’t need to tackle this chore as you are simultaneously wrestling with other issues associated with your beneficiary’s death.
You can also elect to have more than one beneficiary. We cover below how that can work for family members. But you might not want to limit your payout to just your family.
In particular, if you own or co-own a business, you may want to arrange for a payout to your colleagues, either from your personal life insurance policy or another designated to the business. This insurance -- archaically known as "key man coverage," from the days in which business owners were almost invariably male -- can help the business stay afloat as it undergoes the (possibly lengthy) search for your replacement, according to Burke.
Decide how benefits will be distributed
Remember, you can name more than one person to receive death benefits from your policy. But if you do so for family members, you need to decide how the policy proceeds will be distributed.
There are two main choices, and it’s important to understand the difference between them because it determines how benefits are divvied up, Buhrmann says.
The simplest of the two is Per Capita distribution, in which the policy’s benefit is divided equally among everyone you list as a beneficiary. This is the option to choose if, for example, you want your three children to each receive a third of the payout, regardless of the number of heirs each may have.
But there are advantages to the other choice, which is known as Per Stirpes -- after the Latin word for “branches.” Under Per Capita distribution, if one of your children dies before you, and themselves have children, their family would not receive any policy benefits. Instead, those would be distributed only to beneficiaries who are still alive.
Under Per Stirpes distribution, by contrast, benefits are distributed equally among all branches of the family -- thus allowing you to provide for your grandchildren in the event their parents pass away before you do. The children of a deceased beneficiary would receive the share of the proceeds that would have gone to their parent, were he or she still alive, divided equally among them.
Should you for any reason prefer to skip benefiting a child and directly benefit a grandchild, you can do so by naming that child of your child as a beneficiary. But that can involve extra contingencies in case the grandchild is a minor when they come into their insurance benefit.
Elect when and how minors will receive their funds
It’s prudent to take steps in advance in case children or grandchildren become beneficiaries of your life insurance when they are still minors -- defined as under the ages of 18 or 21 in most states, and 25 in a few. However, you might not be comfortable having, say, an 18-year-old inherit a large sum because “what they do with that money could make you roll over in your grave," says Burke.
There are several ways to prevent your children from potentially blowing their benefits on NFTs and streetwear. The easiest option, advises legal site Nolo.com, is to instruct a trusted adult beneficiary to use the money for the children's benefit. More formally, the site says, you can also elect to name an adult custodian under your state's Uniform Transfers to Minors Act (UTMA). Most insurance companies permit this and have forms for it.
Alternatively, you can name a family member or attorney as trustee of the funds. “A testamentary trust receiving the proceeds and managing them accordingly may be more desirable" than leaving an inheritance in the hands of a teen, Burke says.
Let your beneficiary know they’ve been selected
The people you choose to benefit from your life insurance shouldn’t be in the dark about their status. Buhrmann urges not only informing them that they’re a beneficiary but of the amount of the benefit they will receive, “so they can be prepared to act properly." Inform not only family members but any business partners who will be beneficiaries, Burke adds.
Adjust beneficiaries as your life changes
Life isn’t static, and just as you should adjust the policy itself in step with changing circumstances, including a divorce, your list of beneficiaries should also be re-evaluated from time to time. "When a major life event such as a divorce or death occurs, it's so important to update beneficiaries," says Burke.”You'd be surprised at how often people forget to do this.”
Buhrmann seconds the importance of treating insurance policies as living documents. As with owning a car, he says, “it’s important that you 'look under the hood' periodically and perform routine maintenance” on your policy. He suggests scheduling annual reviews of your life insurance with your financial advisor or insurance agent.