When applying for a life insurance policy, you will be asked about naming primary and contingent beneficiaries. In my experience, those applying for the policy spend very little time thinking about the answer to this question. And, in reality, for most people at the time of application, there may not be much to think about. “It should go to my spouse.” Yes, it should. If you are to pass away before your spouse. But what if the situation becomes much more complex?
First, let’s review a couple of terms mentioned above. A primary beneficiary is one who is to receive the benefit first. You can name one or more primary beneficiary and you can choose what fraction of the benefit should go to each. It is common to name a spouse, adult children, or other family members as primary beneficiaries. In some instances, a church or charity is named as a primary beneficiary. Contingent beneficiaries are the “backup plan”. If your primary beneficiaries predecease you or pass away at the same time, those listed as contingent beneficiaries would receive the benefit. As with primary beneficiaries, you can name one or more contingent beneficiaries.
Here are some items to consider.
The biggest advantage to having individuals named as beneficiaries on your life insurance policies is that payment is made directly to them, without income tax implication, and without going through a probate process. If there isn’t a proper beneficiary named, the funds from the insurance policy will become part of the deceased’s estate and will be subject the full settling of the estate and any implications that accompany it.
Naming Minor Children
Most people know who they want to name as their primary beneficiary. But when asked about the contingent beneficiaries, there is less certainty. “Can I just name my kids?” If they are minor children, it is likely not in your interest to do so. If a minor is the beneficiary of a policy, a guardian must be appointed to receive and manage the proceeds. One exception to this rule is if the beneficiary designation provides that a minor’s interest in the proceeds be paid to a custodian under the Uniform Transfers to Minors Act.
Perhaps the kids aren’t minors anymore. But, maybe you don’t quite trust them with the whole estate, either. Properly drafted beneficiaries can act as a de facto trust by allowing you to control the rate of policy distribution. This can be done by giving specific rules about the distribution of the funds, by requiring the establishment of an annuity to distribute funds or some related method.
In certain instances, life insurance policies are in force that have different parties as owner, insured, and beneficiary. In such a setup, the proceeds from the policy that end up in the hands of the beneficiary will be treated as a gift for tax purposes. Income tax would then be due by the recipient. This can occur in situations where there is a policy owned by a person’s employer or when there may be 3 generations of a family involved in a policy. For example, a grandparent may have, at one time, purchased a policy on a child. The grandparent has always been listed as the owner. Time has passed. Originally, the grandparent had named themselves as the beneficiary. But now the insured has their own family so, the grandparent names his grandchildren as the beneficiaries, but continues to be the owner of the policy. Gifting rules may apply in this situation.
These are just a few of the topics to consider with regard to the beneficiaries that you name on your life insurance policies. If it has been some time since you looked at your policy, it may be time to review your options.