Typically, people who need to provide for others after death will purchase a life insurance policy. Although there are many types of life insurance policies, the common thread between them are beneficiary designations. In simple terms, once the policy owner perishes, the listed beneficiary will receive the proceeds from the policy. However, listing beneficiaries on a life insurance policy needs careful attention for reasons mentioned in the article List Your Beneficiaries Wisely in Your Estate Plan. Otherwise, after death, unintended consequences may occur. So, to avoid unintended consequences, properly listing beneficiaries on a life insurance policy is essential.

The Life Insurance Policy and Community Property States

Generally, for people living in a community property state, spouses equally own property bought with shared funds. Therefore, if the buyer of a life insurance policy wants to list a beneficiary other than the spouse, the spouse will have to give written consent. Otherwise, without written consent, unintended consequences occur because of an invalid listed beneficiary.  

Conversely, there is an exception to the consent rule. If the buyer of the life insurance policy used money not shared with the spouse, such as an inheritance, then spousal consent is avoidable. Regardless, in community property states, careful attention becomes necessary when listing beneficiaries on life insurance policies.

Listing Children as Beneficiaries on a Life Insurance Policy

Ideally, it’s best to avoid listing minor children as beneficiaries directly on life insurance policies. Typically, insurance companies will insist that an adult handle the proceeds. If the buyer doesn’t comply, the insurance company will send the matter to court. The court will then appoint a custodian to handle the proceeds. Therefore, listing minor children as beneficiaries on a life insurance policy could be a costly and intrusive mistake.

Fortunately, there are a couple of ways to avoid costly mistakes and to ensure the children receive the proceeds:

• Name an adult as custodian using the Uniform Transfer to Minors Act (UTMA). The act allows the custodian to manage the money in the child’s best interest until the child becomes of age. In most states, the age is 21. Also, insurance companies in most states recognize the UTMA except for South Carolina. If using this option, list the approved custodian as the beneficiary on the life insurance policy.

• Set up a trust for the children and name a trusted adult as the trustee. In the trust, list the children as the beneficiaries. To use this option, list the trust as the beneficiary of the life insurance policy. This will allow the trustee to manage the proceeds for the children’s benefit.

Finally, to avoid bureaucratic methods, simply list a trustworthy adult as beneficiary on the life insurance policy, if possible. Typically, when estate planning for minor children, people usually name a guardian. In this scenario, list the guardian as the beneficiary to the life insurance policy. If you are entrusting your children’s life with this person, then you should trust that this person will use the proceeds in the children’s best interest.

Beneficiaries with Special Needs

In some instances, people buy life insurance to pay for continued care of a special needs person. They will list the special needs person as beneficiary to use the proceeds for their care.  Although the intent is honorable, unintended consequences could result. Unfortunately, if the special needs beneficiary receives too much of a cash gift from the policy, the loss or reduction of any government assistance could result.

To avoid such an occurrence, creating a special needs trust or a supplemental trust is necessary. By creating a trust, the policy owner would list the trust as the beneficiary. As with minor children, the trust would allow the trustee to manage the proceeds in the best interest of the intended beneficiary and avoid jeopardizing any government assistance.

Simple Tasks to Avoid Unintended Consequences

While listing beneficiaries on a life insurance policy, some people get lazy. Accordingly, unintended consequences occur such as creating conflict and confusion among the beneficiaries. To avoid unintended consequences, the policy owner should abide by the following rules:

• Use full names when listing beneficiaries. If you use an ambiguous group name such as “my children”, conflict may result. So, specifically identify each beneficiary.

• When changing a beneficiary on a life insurance policy, the change must happen through the insurance company, not the will. Usually, insurance companies will pay proceeds only to the beneficiary listed on the policy.

• Name alternate beneficiaries in the event that a primary beneficiary predeceases the policy owner. This will ensure the proceeds of the policy will go to a beneficiary and not the estate.

• Update the life insurance policy anytime there is a life changing event such as a marriage or divorce. In fact, every few years the policy owner should review the policy and make updates if necessary.

• While estate planning, the policy owner must tell the executor and the policy beneficiaries about the life insurance policy. Otherwise, the life insurance policy could remain unknown and never collected.

These simple tasks are crucial if the policy owner is serious about providing for the intended beneficiaries after death.

Decide on Per Stirpes or Per Capita

When a life insurance policy owner uses many beneficiaries, the insurance company may ask the owner if he/she wants them to inherit ‘per stirpes” or “per capita”.  As mentioned in the article Designating Beneficiaries Using Per Stirpes or Per Capita, both designations relate to the death of a beneficiary. If the policy owner decides on “per stirpes”, that means descendants of the deceased beneficiary will inherit the decedent’s share of the proceeds. Conversely, if the policy owner decides on “per capita”, all remaining beneficiaries will share in the proceeds equally.

The policy owner must give serious thought to each designation because conflict could result. Using “per stirpes” doesn’t affect the other primary beneficiaries whereas “per capita” does. If the owner decides on “per capita” all the primary beneficiaries may receive reduced proceeds if the descendants of the deceased beneficiary can inherit. This adds to the pool of beneficiaries and could contribute to conflict among the beneficiaries. As a result, to avoid conflict, “per stirpes” is the common choice.

A Final Thought on Beneficiaries and Life Insurance Policies

Although this article mentioned many ways to properly list a beneficiary on a life insurance policy, it’s simply an overview. Generally, insurance companies dictate the rules on how beneficiaries inherit. Therefore, prospective buyers of life insurance must be clear on how the insurance company pays proceeds to the beneficiaries. After learning the rules, the policy owner should list the beneficiaries accordingly.

Was this article helpful? Do you understand why listing beneficiaries for life insurance policies takes some thought? Share your comments or questions in the comment box below. 

Reference

Naming a Beneficiary for Your Life Insurance Policy by Mary Rudolph, J.D., NOLO 

Recommended Reading 

Plan Your Estate– The book will help you understand life insurance policies in your estate plan.