The decision to purchase life insurance is a big one. While you may be thinking about your family, it’s important to think about the beneficiaries of your estate plan. A life insurance policy leaves behind financial assets and can help provide for loved ones in the event of an unexpected death.
But before selecting who should receive those benefits, it’s important to consider what will happen with any money left over after expenses are paid off from the life insurance policy proceeds and other assets have been distributed.
This blog post discusses 6 questions to consider when selecting beneficiaries for a life insurance policy, including what are your beneficiary options, and whether the money would negatively affect a beneficiary.
The process of naming a beneficiary for your life insurance policy seems pretty straightforward. You’re just deciding who will receive your policy’s proceeds when you pass away, right? But, as with almost everything in life, it’s a bit more complicated than that.
Remember it does not have anything to do with you: the choice should be based on how the money will affect the beneficiary’s life after you pass away. The likelihood is that if you have purchased life insurance, you did so to make someone’s life better or easier in some way after your death. But unless you consider all of the unique circumstances involved with your choice, you might actually end up creating additional problems for the people you love.
Here are the important questions to ask yourself when choosing your life insurance beneficiary:
What are you intending to accomplish?
The first thing to consider is why you are buying life insurance. On the surface, the reason could be that it is simply the responsible thing for adults to do. Our recommendation is to dig a little deeper and figure out what you intend to accomplish with your life insurance.
- There are many different goals that could be accomplished with life insurance. It might make sense for you to consider these questions.
- What if you’re married and wish your spouse and kids had more money when you’re gone?
- Are you are a single person without children trying to cover the funeral expenses?
- Are you planning on leaving your grandchildren a college fund?
- Is it your intention to make sure your business continues after you are gone?
- It may be that you are buying life insurance in order to avoid future estate tax burden?
The only person who can determine the real reason you purchased life insurance is you. It is crucial to know the answer to this question, since it determines what kind of life insurance you should have in the first place. And if you first clearly understand what you’re trying to accomplish with the policy, you’ll be able to better decide who the beneficiary should beneficiary.
What are your beneficiary options?
When you get a life insurance policy, you will be asked to name a primary beneficiary—the person you want to receive the insurance proceeds upon your death. If you fail to name a beneficiary, the proceeds will go to your estate.
A probate court judge will direct where your insurance money goes if your estate is the beneficiary of your life insurance policy. Moreover, this process can tie up your life insurance proceeds in court for months or even years.
Be sure to name at least one primary beneficiary in order to prevent this from happening to your loved ones.
You should designate at least one contingent (alternate) beneficiary in case your primary beneficiary passes away before you. You may want to think about naming at least two contingent beneficiaries in the event the primary and secondary beneficiaries are both deceased. Even these seemingly straightforward choices are often more complicated than they appear because of all the options available.
As an example, you can name multiple primary beneficiaries, like your children, and distribute the money according to your wishes. Furthermore, the beneficiary does not necessarily have to be a person. Any non-profit, charity, or business can be the primary beneficiary (or contingent beneficiary).
It’s important to note that when naming a child as a primary beneficiary or contingent beneficiary, a legal guardian must be appointed to manage the funds until the child reaches the age of majority. This can lead to numerous difficulties, which is why you should consult with an experienced estate planning law firm like us if you’re considering this option.
Ultimately, choosing beneficiaries should be based on which person(s) or organization(s) you think will most benefit from the money. In general, you can select the following beneficiaries as beneficiaries:
- one individual
- Two or more people – you decide how the money is divided between them
- A trust that you created
- Your estate
- A charity, a nonprofit, or a business
Does your state have community-property laws?
The primary beneficiary will likely be your spouse, if you’re married. But unless you live in a state with community-property laws, you can technically choose anyone: a close friend, your favorite charity, or simply the person you think needs the money most.
However, if you do live in a community-property state, your spouse is entitled to the insurance proceeds, and must sign a form waiving their rights to the insurance money if you want to name someone else as beneficiary. Currently, community-property states include Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin.
Are any of your beneficiaries minors?
Although you can technically name a minor as beneficiary of your life insurance policy, it’s a bad idea to do so. Insurance companies won’t pay a death benefit to anyone until they reach the age of majority.
The proceeds of your estate would be distributed to a court-appointed custodian when you die, usually at a financial cost to your beneficiary. This applies even when the minor has a living parent.
This means that even the child’s mother or father, if living, would be required to apply to the court for guardianship if he or she wanted to manage the funds. In some instances, the court would appoint a paid fiduciary to hold the funds if the parent is unable to be appointed (for example, if they have poor credit)
The best way to ensure your heirs receive your insurance proceeds is to set up a trust rather than name your minor child as beneficiary. You can then decide who would manage your child’s inheritance, and how the insurance proceeds should be used and distributed.
Would the money negatively affect a beneficiary?
When reviewing your insurance funds, take into consideration how you might help your beneficiary in your absence and the potential harm it may cause. This is especially true when the beneficiary is a young adult.
For example, a lot could go wrong if a young adult receives a large sum of money from an insurance company. They could quickly spend all of their inheritance on items that will not help them with their future. The worst case scenario would be if the newly found funds paid for an existing substance abuse issue.
Some life insurance companies offer the option of having your death benefit paid out in installments, giving you the choice of when your beneficiary will receive the money. As discussed earlier, you can set up a trust to receive the insurance payment, so you can control the conditions for using the proceeds.
For example, you could create a trust that is funded by the life insurance proceeds that are kept inside the trust. A co-trustee of the trust could ensure that the life insurance proceeds are used for beneficiary’s benefit while also protecting the funds from lawsuits, future creditors, and from divorce.
Is the beneficiary eligible for government benefits?
It’s important to consider how your life insurance may negatively affect a beneficiary when it comes to those with special needs. When it comes to those with special needs, you must think about how your life insurance money might disqualify them from government benefits if you leave a life insurance payout directly to them.
A person with a disability who receives a gift or inheritance of more than $2,000 may be disqualified from receiving Supplemental Security Income and Medicaid. An individual with special needs SHOULD NEVER be named beneficiary on an individual’s life insurance policy because life insurance proceeds are considered an inheritance under the law.
A “special needs” trust would ensure that an individual with special needs would not be disqualified from receiving government benefits. So, the money will not pass directly to the beneficiary upon your death, but will be managed by a trustee you specify and dispersed according to the trust’s terms without affecting eligibility for benefits.
If you have a child with special needs, see us to ensure your child has the proper planning in place, not just for insurance proceeds but for his or her lifetime of care.
Make sure you’ve considered all potential circumstances
These are a few but not all of the questions you should consider when selecting a beneficiary for a life insurance policy. Contact our dedicated estate planning law firm to make sure that you consider all the issues that are relevant to your situation.
If you have questions regarding whether you need a trust to protect your loved ones life insurance proceeds after you are gone, contact Colorado Wills and Estates to schedule a Peace of Mind Planning Session today.
This article is a service of Brian Musell. I go beyond drafting documents; I ensure that your informed and empowered decisions about life and death are made for yourself and the people you love. That is why I offer a Peace of Mind Planning Session during which we will explore what is important to you, and how we can protect your loved ones once you are gone.