Picking a beneficiary on a life insurance policy is a crucial step when you get coverage because it determines who receives the death benefit if you die within the policy’s term.
Whether you’re the person buying the policy or you’re the beneficiary, it’s important to understand how the process works, how to make changes, and what happens when the policy pays out.
What Is a Life Insurance Beneficiary?
When you purchase a life insurance policy, you can name a beneficiary, which can be a person or an entity. (It’s also possible to have multiple beneficiaries.) If you die during the term of the policy, the beneficiary receives the death benefit—sometimes also called the face value.
As the policy owner, you can choose any of the following as beneficiaries:
- One person
- Two or more people
- Your estate
- A trust
- A charitable organization
It usually is not a good idea to name minor children as beneficiaries. This is because most states require an adult guardian to manage minor assets—and the process of a family member becoming a guardian can be expensive and time-consuming. In this case, you could establish a trust or custodial account for the benefit of your child and direct death benefit proceeds there. Contact your insurance company for the correct forms and procedure.
If you neglect to select one, your estate becomes the de facto beneficiary.
If you are the beneficiary on a life insurance policy and your loved one has died, contact the insurance company and provide a death certificate to start the payout process.
How Do Life Insurance Beneficiaries Work?
When naming beneficiaries, it’s critical that you provide correct information, such as their full name and Social Security number, so they can be easily identified and to minimize potential disputes.
For example, if you simply write, “spouse of the deceased,” then get divorced and remarried, both your ex-spouse, who was married to you when you bought the policy, and your current spouse may try to claim the death benefit.
Primary and Contingent Beneficiaries
In many cases, it makes sense to also name one or more contingent beneficiaries on a life insurance policy. A contingent beneficiary is someone who receives some or all of the death benefit in the event that the primary beneficiary (or beneficiaries) are dead or cannot be found.
Let’s say you purchase a policy with a $1 million death benefit, and name your husband or wife as the beneficiary. If you die during the policy’s term, your partner will receive the full death benefit.
However, if your primary beneficiary dies before you, you want to make sure the benefit passes on to your children, so you add your three adult children as contingent beneficiaries, each with an equal share. If your spouse dies before you do, your children will each receive one-third of the death benefit.
If you name more than one beneficiary, be sure to designate a specific percentage of the death benefit that each should receive.
Per Stirpes or Per Capita
Another thing to consider when naming beneficiaries is whether to choose a per capita or per stirpes designation. Each of these designates how the death benefit should be distributed if one or more of your beneficiaries dies and no additional contingents are listed on the policy.
Per capita (“per head”), is usually the default designation, meaning it doesn’t require you to make a special selection. In this case, each of your living beneficiaries receives an equal share. So if you have three adult children and one dies before you, the remaining two children each receive one-half of the face value instead of one-third.
If, however, you choose to designate per stirpes and one of your beneficiaries dies before you do, that beneficiary’s descendents will receive their amount. Take the example above. If one of your three adult children dies before you and is survived by two children, a per stirpes arrangement would give your two grandchildren the one-third that your original beneficiary was entitled to—each grandchild would receive one-sixth of the death benefit.
Some beneficiary designation forms will have a box you can check to indicate per stirpes. If no box exists, check with your insurer to make sure a per stirpes designation is acceptable and if you can write it in.
Life insurance can be a valuable estate planning tool, but you may also benefit from consulting an estate planning attorney to create a plan that effectively accomplishes your goals and protects your interests.
Who Can Change the Beneficiary on a Life Insurance Policy?
Typically, you’ll want to designate at least one beneficiary during the application process for life insurance, but that doesn’t mean you can’t change it later. If you’re the owner of the policy, you can generally change or add beneficiaries at any time.
For example, you may decide to make changes if you get married or divorced, have a child, or for any other reason you deem appropriate.
However, if you’ve previously designated a beneficiary as “irrevocable,” you’ll need to get their consent to make any change to their designation (usually by signature on the policy change form).
Also, there are some cases in which your insurance company or state may restrict who you can name as a beneficiary. For example, married couples who live in community property states may be required to get spousal approval before they can name anyone else as a beneficiary.
If you wish to change or add a beneficiary, request a “beneficiary change form” from your insurer.
Do Beneficiaries Pay Taxes on Life insurance Policies?
When taken as a lump sum, a life insurance death benefit is usually not considered taxable income. However, there are instances in which you might owe some tax.
For example, if the beneficiary chooses to receive the death benefit in installment payments or as a life insurance annuity, or if the policy owner designates that the benefit be paid in installments, any interest the insurer pays on top of the death benefit would be considered taxable income.
Also, if your death benefit is paid to your estate instead of to an individual or entity, it may be subject to estate taxes—though in 2021, estates worth less than $11.7 million are exempt.
- A life insurance beneficiary receives the policy’s death benefit if the insured dies during the policy term.
- You can name an individual or entity, and you can designate multiple beneficiaries, including primary and contingent beneficiaries.
- It’s crucial that you provide accurate identifying information for your beneficiaries so they can be easily found and to minimize disputes.
- Life insurance proceeds generally aren’t taxable, but some portions may be in certain circumstances.
- Make sure you understand the life insurance rules for your state and how to handle naming minors as a beneficiary before you proceed.