Who Should Be Your Life Insurance Beneficiary?
Updated: Oct 5, 2020
The purpose of life insurance is to give someone money if you die. The beneficiary is the person who receives a death benefit payment when an insured passes away during the covered term. Whether you leave behind $50,000 or $1 million it’s important to choose who receives the money and keep that person up to date on your policy.
You can generally add one or more life insurance beneficiaries. If you put multiple people, you can divide the proceeds evenly or give a specific percentage to each. You can name a primary beneficiary who is ‘first in line’ to receive funds such as your spouse or partner, and then you can name a secondary beneficiary such as adult children or a charity. If you have minor children, you may want to consider a custodial account to receive life insurance proceeds.
Under the Uniform Transfers to Minors Act, you can set up an account for your child with a financial institution, such as a bank or life insurance company. This is in effect within most states. You name a custodian — a person you trust — who manages the life insurance money, and other assets you might have in the account, as they see fit while the child remains a minor.
You can also establish a trust for your child and name the trust as the beneficiary of the policy. This is a more precise, albeit complex, way to ensure that your exact wishes for your children are followed. The trust, which is a legal document, spells out the person you choose as the trustee and how you’d like the money to be managed and spent.
To ensure the trust is set up properly, consult with a qualified attorney.
What if I Don’t Choose a Beneficiary?
If you don't choose a beneficiary, the policy generally pays out to your estate. That puts the cash up for creditors and lenders who will try to get the money for unpaid debts instead of writing a check directly to your loved ones.
What About My Will or Trust?
Life insurance beneficiaries are final. A will or a trust controls what happens to your assets like bank accounts, investments, real estate, and possessions. However, life insurance is outside of a will or trust. You have to update your life insurance beneficiaries through your provider; it cannot be done through your will. If you don't keep them updated, the results can be catastrophic for your family. For example, if you get divorced and forget to update your policy, your ex will receive your death benefits.
How are Death Benefits Paid?
Since the inception of the industry more than 200 years ago, beneficiaries have traditionally received lump sum payment of the proceeds. The default payout option of most policies remains a lump sum, which is typically tax free.
Another option can provide a stream of income, or an annuity, in which the proceeds and accumulated interest are paid out regularly over the life of the beneficiary. The policy owner may select a predetermined period to provide his or her family a guaranteed income stream for a period of five to 40 plus years. There may be tax due on the interest component of an annuity payout.
Some life insurance companies have designed policies that allow their policyholders to draw against the face value of the policy in the event of a terminal, chronic or critical illness. You may want to review this option or a long term care rider while shopping for life insurance.
“Tomorrow is never guaranteed to anyone,young or old. Today could be the last time to see your loved ones, which is why you mustn't wait; do it today, in case tomorrow never arrives.” Gabriel García Márquez
Have further questions?
Life insurance is a complex topic. If you’ve questions or need guidance in navigating this topic, please don’t delay. Reach out to me. Tomorrow is never guaranteed to anyone. Let me help you achieve peace of mind knowing your family is taken care of if you were to pass away unexpectedly.
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About the Author
Peter Newman is the president of Peak Wealth Planning. He offers financial planning, investment management, retirement income, insurance and estate planning advice. Peak Wealth is a fee only financial advisor based in Champaign, Illinois.