Life Insurance Beneficiary Rules: A Complete Guide

Most of us don’t like to think about our own mortality, but when we have loved ones, we want to make sure they’re taken care of if and when we pass away.

Life insurance policies are a great way to provide for your family in the event of your death, but having all of the information in your policy clear, accurate, and up to date is essential. Making mistakes when it comes to choosing a life insurance beneficiary can lead to significant inconveniences or even losses of benefits.

To make sure the people you care about receive your death benefits, it’s important to designate your beneficiaries properly.

Keep reading to learn more about life insurance beneficiary rules you need to be aware of. By getting informed about how life insurance payouts work, you can take steps to make sure your benefits go to the right people.

This article will cover what a beneficiary is, how to designate a beneficiary, what to do if you want to designate multiple beneficiaries and the various rules you need to be aware of if you live in a state with specific laws in place surrounding life insurance.

Beneficiaries Defined

A life insurance beneficiary refers to the person, people, entity, or entities that are legally designated to receive all or part of an insured individual’s death benefit once he or she has passed away.

In many cases, beneficiaries are an individual’s spouse, children, siblings, or others who are close to the insured. In other situations, beneficiaries can include charitable organizations, nonprofits, or similar businesses.

Receiving a life insurance benefit is similar to receiving benefits designated in an individual’s will, but the life insurance payout process is usually simpler than receiving the inheritance specified in a will.

Beneficiaries who are designated inheritance benefits in a deceased individual’s will have to wait for probate to process the estate plans before they can claim their benefits. Beneficiaries who are listed in an individual’s life insurance policy typically only need to provide documentation that verifies the insured’s death. Though there is a waiting period to receive life insurance payouts, it’s usually a lot shorter than waiting for probate.

Important Beneficiary Designation Guidelines

To make sure the right parties receive the death benefit included in an individual’s life insurance policy, it’s important to designate a beneficiary. A beneficiary designation is usually simple, but making the insured party’s wishes as clear as possible can help eliminate any complications when the time comes to process the policy’s payout.

Choosing a beneficiary involves filling out a Beneficiary Designation Form, which is a legal document that the insurance company will reference in order to process the payout correctly. There are two beneficiary levels to consider, primary and contingent.

A primary beneficiary is an individual chosen to receive an insured person’s death benefits after their passing. A contingent beneficiary is essentially a backup, an individual or entity that receives the insured’s death benefit if the primary beneficiary is deceased at the time of the insured’s death.

For example, if the insured individual lists a spouse as the primary beneficiary but both parties pass away at the same time, the contingent beneficiary would receive the death benefit.

When designating a beneficiary, it’s important to name the individual or entity. Otherwise, complications may arise in situations where the term “husband” or “wife” or “charity” is arguable.

Let’s assume the insured individual was twice divorced, remarried, and wanted his or her husband or wife to receive the death benefit listed in the policy. Using only the term “my husband” or “my wife” could imply that the insured intended for the payout to go to the first, second, or third spouse fitting the title listed.

Providing the following information for the intended beneficiary helps clear up any confusion or room for interpretation.

• The beneficiary’s full name
• The beneficiary’s full address (street, city, state, zip code, country, etc.)
• The beneficiary’s contact information
• The beneficiary’s social security number
• The beneficiary’s date of birth

Multiple Beneficiary Rules

Insured individuals may designate several beneficiaries, meaning that each individual or entity will receive a specific portion of the payout.

Making arrangements for multiple beneficiaries can be assigned as a specific percentage, or through what’s known as either a Per Stirpes or Per Capita arrangement.

• Percentage: The insured might designate two beneficiaries, and each individual may be assigned 50% of the payout.
  
  Child 1: 50%
  Child 2: 50%
• Per Stirpes: This arrangement states that the death benefit is distributed evenly among the listed family members. Let’s say one of the insured’s children died before him, but that child had two children as well. Upon the insured’s death, the surviving child would receive 50% of the benefit while the deceased child’s surviving children would each receive 25% as well.
  
  Child 1: 0% (deceased)
  Child 2: 50%
  Grandchild 1: 25%
  Grandchild 2: 25%
• Per Capita: In this arrangement, the death benefits would be distributed equally among the parties eligible to receive a payout. This means that the surviving child and the deceased child’s surviving children would each receive 33.3% of the benefits.
  
  Child 1: 0% (deceased)
  Child 2: 33.3%
  Grandchild 1: 33.3%
  Grandchild 2: 33.3%

Life Insurance Beneficiary Rules

Beneficiary designation in an individual’s life insurance policy overrides other estate planning arrangements. If an individual has one party listed as a beneficiary in his or her will and a different party listed in his or her life insurance policy, the life insurance beneficiary receives the insured’s benefits.

In addition, several states also have community property laws in place, which means that if an individual is married, each spouse has shared, equal rights to assets. In community property states, an insured individual who wants his or her death benefits to go to a person or entity other than his or her spouse needs to have that spouse formally waive his or her rights to the benefits.

Community property states include Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin.

In these states, spouses can also contest his or her spouse’s benefits being paid out to a different beneficiary if the deceased spouse was not mentally competent at the time the decision was made.

Additionally, in a community property state, the length of time a couple has been married will determine the proper payouts of death benefits. Suppose a couple was married for five years and a life insurance policy was taken out at that time. If the couple divorces and the insured individual remarries, the new and former spouse may be entitled to benefits. Let’s assume both marriages lasted five years before the insured’s death occurred. Since both marriages were equal in length, community property states would likely pay each spouse 50% of the life insurance death benefits.

Contingent Beneficiary Rules

For an individual to become a beneficiary in the event that the primary beneficiary has died before the payout is processed, that individual has to be named in the policy as a contingent beneficiary.

If no contingent beneficiary is listed, one does not exist. If the contingent beneficiary dies before the death benefit is paid out, probate gets involved. This might result in lengthy wait times, after which the insured’s benefits would be paid to his or her estate according to the state laws in place.

To avoid this potential setback, insured individuals can often name a trust as a third beneficiary, which will help keep life insurance processes out of probate court.

Death Benefit Taxes

In most situations, life insurance beneficiaries don’t have to pay income taxes for life insurance proceeds. Additionally, beneficiaries usually will not have to report death benefits on their income tax returns.

However, if a life insurance policy is included in an insured individual’s estate and that estate exceeds the listed exemption value set by federal or state laws, death benefits may be subject to estate taxes.

Minor Beneficiaries

If an insured person’s policy names someone under the age of 18 as a beneficiary and the insured person passes away before the child becomes a legal adult, the payout may be provided to the beneficiary’s legal guardian in the child’s name. The beneficiary will likely not have access to the funds until he or she becomes an adult.

An alternative to this practice involves setting up a trust for the minor beneficiary. This way, if the insured individual is at all worried about the child’s legal guardian accessing the benefits, the payout will be protected. Trusts can also be designed so that the child may benefit from the payout before reaching adulthood.

Processing a life insurance payout is often a simple process, but several factors can affect how quickly and easily benefits are distributed. If you’re not sure about the status of your life insurance policy, it’s in your best interest to contact your life insurance company to discuss your concerns. Ask about the laws in your state, discuss your estate plans, and work with your agent to set up an airtight policy.

Making preparations and adjusting to life after losing a loved one can be incredibly stressful and difficult. To make the grieving process as easy for your family and friends as possible, do your best to make sure your life insurance policy covers your wishes and plans with as little room for debate as possible.