In a life insurance policy, a beneficiary is the person or organization that receives the life insurance death benefit upon the passing of the insured policy owner. They are the individuals or organizations directly paid by the life insurance company, and are contractually entitled to the life insurance proceeds.
It’s important to remember that in the case of a life insurance policy, the insured (often the policy owner) is claiming insurance against the asset of their own life, which means they will never receive life insurance proceeds of their policy. This value of the life insurance policy is always paid to the beneficiary, who is named when the policy owner signs their contract with the life insurance company. A beneficiary receives the death benefit of the policy that designated them.
The only time an insured policyholder will receive value from their own life insurance policy is when they surrender their policy for its cash value, exchange their policy for a life settlement, or withdraw the cash savings from a universal or variable life insurance policy. However these are not the intended purposes of life insurance policies, and are never worth as much as the full face value of a policy.
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Who Can be a Life Insurance Beneficiary?
Eligible beneficiaries can be anyone considered to have insurable interest, which is defined as anyone suffering reasonable hardship (financial and otherwise) suffered upon the passing of the insured policy owner. Life insurance beneficiaries tend to be family members, dependents, friends, and in some cases business partners or charities. To name a primary beneficiary a policyholder will need their full name, phone number, social security number, date of birth, and typically their consent.
The proceeds of a life insurance policy may also be routed through financial organizations such as a charity trusts or an estate, which are often used for tax purposes, or to secure benefits when naming a minor beneficiary. These are more complex and one should always consult their life insurance agent as well as as their financial advisor when doing this.
Naming Multiple Beneficiaries
It’s common to name multiple beneficiaries, however it’s important to understand the different types to determine if you are splitting a death benefit among them, or if the benefits are mutually exclusive.
There are two types of beneficiaries: primary beneficiaries and contingent beneficiaries. You can think of these as layers, where the primary beneficiary is the intended recipient of policy’s life insurance benefits, and the contingent beneficiary is the individual or organization who receives the proceeds should the primary beneficiary die before the insured individual.
An example would be a man who names his wife as a the primary beneficiary, and his daughter as his contingent beneficiary. Should the wife die before the policy owner, the life insurance proceeds will go the daughter. Should both be alive, all the proceeds will go the wife, as the primary beneficiary always supersedes the contingent beneficiary, should both still be living at the time of policyowner’s death.
Contingent beneficiaries have levels, and the first beneficiary is also referred to as the “secondary beneficiary” and then after that is the tertiary beneficiary (this can go on as long as necessary). However, these are sequential steps and the life insurance benefits will not be split between these types of beneficiaries.
Naming Minors: If your primary beneficiary is a minor child (defined as under the age of legal consent in the state), the life insurance company will likely require a legal guardian be named as the primary beneficiary. A policyowner can also designate a legal guardian using the Uniform Transfers of Minors Act on their behalf instead of using a legal guardian.
Splitting Benefits Among Multiple Beneficiaries
It’s often the case that a policyowner will want to name multiple family members as equal primary beneficiaries in their life insurance policy, “splitting” the proceeds, so to speak. There are two ways to do this:
- Per stirpes. Named beneficiaries are determined by level of lineage. The example here is when a policyholder has multiple children, and wants to partition their death benefit equally between them. Should one of the primary beneficiaries have died before receiving their portion, the amount they are entitled to would be passed along and divided among their children.
- Per capita. This is similar except in this case, children of deceased primary beneficiaries (useful to think of as the grandchildren in this case) are entitled to an equal amount of proceeds as the original primary beneficiaries. So if a policyowner has 2 children, and one them dies but leaves 3 surviving grandchildren, this would stipulate the life insurance proceeds be split equally 4 ways. This distinction is only applicable should primary beneficiaries be deceased, in which case per capita designation would see greater dilution of benefits among survivor beneficiaries then per stirpes designation would.
In either case it’s always recommended life insurance proceed be partitioned by percentages, rather than fixed dollar amounts. The reason is should a policy exceed or be below its original face value (this is particularly the case with permanent life insurance), then a life insurance company will have to determine how to divide the death benefit, and this could lead to long a and costly legal battle.
How is Life Insurance Paid out to Beneficiaries?
In order for a beneficiary or beneficiaries to receive their claim with the life insurance company, they need to provide a few things:
- A death certificate (a copy works).
- The policy document. This should always be saved somewhere important, and if lost, can be be found with the insurance agent who signed the policyholder.
- A claim form, otherwise known as a “request for benefits.”
Once these are successfully completed, beneficiaries can receive the payout of the policy, either all at once in a lump sum, or in installments (typically annuities). Life insurance proceeds are tax free in almost all cases, so you don’t get taxed for taking a large lump sum.
The benefit of annuities is you have the option to have the death benefit reinvested on your behalf, then paid back to you over time. This could amount to a considerable difference, though it also doesn’t provide the immediate windfall for expenses that is often the intended use case for life insurance. In either case, a direct deposit or check is typically available for receiving funds.
Contesting Life Insurance Beneficiary Designation
Contesting life insurance beneficiaries is fairly common. The bad news (or good news depending on how you view it), is that’s it’s rather hard to change the named beneficiaries.
The most common case for contesting life insurance is in the case of divorce. It can be the case that a policyholder named an original spouse as their beneficiary, and then got remarried. While it’s imperative to always revisit your life insurance policy in the case of a divorce, many times individuals forget, and their life insurance death benefit goes to their original spouse, and not their current surviving spouse.
A notable exception exists in what’s known as the “community property” law, which states both spouses “own equally any income earned during the marriage and any property purchased with that income,” which includes life insurance policies. In this case, a spouse is automatically entitled to 50 percent of the proceeds that were paid for during the marriage (if someone paid for half of their policy while married and then got divorced, the original spouse is only entitled to that half).
Currently there are 9 community property states: Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, Wisconsin. Alaska and Tennessee are considered opt-in states. If you were married to someone who purchased a life insurance policy in one of these states, you are likely entitled to 50 percent of the proceeds paid for during your marriage, unless you signed a waiver allowing your portion to be designated to someone else.
Another case is when an individual has stepchildren, or otherwise important loved ones who they became close with through later life events. These individuals may feel entitled to a portion of the life insurance proceeds, as equals to the named beneficiaries. You may also find a life insurance death benefit contested by the insurance company itself. This happens in the case of murder, a death due to an undisclosed disease or dangerous hobby, or suicide of the policyholder. Life insurance companies have laws requiring honesty on insurance applications, to protect themselves from risk.
In all cases, it’s very difficult to legally challenge the proceeds of a named beneficiary. To avoid having your life insurance proceeds be embroiled in controversy we recommend always naming individuals (not “spouse” or “children”) and regularly revisit your life insurance policy after major life events. It’s very easy to update beneficiaries, and if you haven’t checked on your beneficiaries since your original life insurance application, we highly recommend you do so.