An irrevocable beneficiary is a beneficiary named in a life insurance policy who can only be removed as a beneficiary from the policy if they agree to it. Conversely, a revocable beneficiary can be changed by the policy owner at any time.
Learn the difference between the two types of beneficiaries, why you might choose one over the other, how an irrevocable beneficiary works to manage estate taxes, and the differences between contingent beneficiaries and irrevocable beneficiaries.
Definition and Examples of Irrevocable Beneficiary
Life insurance policies are purchased to pay a death benefit when the policy owner dies. The person who will receive the money is known as the beneficiary. Beneficiaries fall into two categories:
- Revocable: A revocable beneficiary can be changed at any time by the policy owner.
- Irrevocable: An irrevocable beneficiary must agree to any changes in the policy, including their removal as the beneficiary.
An irrevocable beneficiary is a named recipient of a life insurance policy’s proceeds who controls whether any changes can be made to the beneficiary of the policy. If the beneficiary is revocable, then the policy owner controls the changes.
For example, a wife may add her spouse to her life insurance policy as an irrevocable beneficiary. If the couple divorces and the wife wants to take the spouse off her policy, she could not do so unless the spouse agrees to it.
Whether irrevocable or not, the beneficiary may be one or more people, a trust, a charity, or your estate.
How Irrevocable Beneficiaries Work
Beneficiaries are named when a life insurance policy is purchased. For example, a father may want to take out life insurance so his adult children would receive sufficient funds to pay for a big funeral when he passes. He would name the children as beneficiaries, and would specify if they were irrevocable or revocable.
If the father decides he wants a modest funeral, he may want to change the beneficiary to a favorite charity. If the children were listed as revocable beneficiaries, he simply needs to contact the insurance company and fill out a form to make the change. But if they were listed as irrevocable, then he needs to receive signed approval from each child before the insurance company will make the change.
In addition to beneficiary changes, other policy changes including withdrawals from the cash value, policy loans, policy surrender, and changes in ownership must also be approved by any irrevocable beneficiaries.
But by making a beneficiary irrevocable, a life insurance policy can ensure that the beneficiary is protected from unexpected changes.
Why Choose an Irrevocable Beneficiary?
Designating an irrevocable beneficiary may be something you choose if you want to provide for that person no matter what happens and you’re comfortable, essentially, giving them ownership of the policy. It may also be something you’re required to choose. For example, in a divorce, you could be ordered by the court to name your spouse as an irrevocable beneficiary.
Having an irrevocable beneficiary on a life insurance policy can serve another purpose, however, and that has to do with estate taxes.
Irrevocable Beneficiaries and Inheritance Taxes
Life insurance benefits are generally exempt from income taxes, and may be exempt from estate taxes as well. But there are plenty of exceptions to that rule. People who are likely to leave an estate larger than the IRS estate tax exemption (currently $11.7 million) need to be especially careful so that they do not run into problems.
For a life insurance policy to be exempt from estate taxes, it must be considered the property of the beneficiary. If the policy owner does not have control, then the IRS says the policy purchaser does not have an ownership interest. The policy purchaser may pay for the policy (and be considered to be the owner by the insurance company), but if the purchaser has named an irrevocable beneficiary, they do not have control of the policy after the initial transaction. In other words, if an irrevocable beneficiary is named, death benefit proceeds can be exempt from estate taxes.
If the policy owner retains the ability to cancel, surrender, borrow against, or pledge the policy, they may be considered an owner and the death benefit may not be exempt from estate taxes.
To use life insurance to pay estate taxes, a policy purchaser needs to make sure benefits will not be paid to the estate, or they will increase the value of the estate for tax purposes. Instead, the policy beneficiary (and owner) can be an irrevocable life insurance trust (ILIT). The benefits are then untaxed, as is the trust. The specifics can be complicated, so anyone considering this should consult an estate attorney for advice.
Why Choose a Revocable Beneficiary?
Choosing a revocable beneficiary is common, and it does not mean that the policy purchaser is fickle—the choice ensures flexibility.
For example, someone may want to provide benefits for their spouse but also want to be able to change the beneficiary in the event of divorce or death. Or they may simply want to be able to borrow or withdraw from their life insurance policy without obtaining the spouse’s permission. This calls for a revocable beneficiary.
Or parents may want to name adult children as revocable beneficiaries until they’re financially secure. If this comes to pass, the parents may choose a charity or other beneficiary at their discretion.
Naming children as life insurance beneficiaries can create complications if the parent dies while children are still minors. It’s best to avoid naming minor children as beneficiaries or to designate a custodian when doing so.
Contingent Beneficiaries vs. Irrevocable Beneficiaries
One concern many people have with irrevocable beneficiaries is that the named beneficiary could die before the policy owner. A solution for this is a contingent beneficiary who would receive the funds if the named beneficiary dies first. A policy owner may name their spouse as an irrevocable beneficiary, with a charity as a contingent beneficiary in the event of the spouse’s death.
Another option is to name the policyholder’s estate as the contingent beneficiary. This way, the funds that the original beneficiary would receive will be distributed to the estate.
A best practice is to name the contingent beneficiary at the time that the insurance policy is purchased. A contingent beneficiary can be revocable or irrevocable, the same as with the primary beneficiary.
- An irrevocable beneficiary of a life insurance policy cannot be changed without the approval of that beneficiary.
- A revocable beneficiary of a life insurance policy can be changed at any time, giving the policy purchaser more flexibility.
- An irrevocable beneficiary must give their consent for policy changes, such as loans, withdrawals, surrender, and changes in ownership.
- Policies with irrevocable beneficiaries may have advantages for people who will owe estate taxes.