Selecting a beneficiary for your life insurance policy is a decision that demands careful consideration. As your choice determines who will receive the funds when you pass away, it is a critical factor in financial planning. The following information can help you make an informed decision.
What Is a Beneficiary?
A beneficiary is the person or entity you designate to receive the death benefit from your policy. You have the option to name multiple beneficiaries and specify the percentage of the payout each will receive. You can name individuals, trusts, charities, or even your estate as beneficiaries. The choice depends on your financial goals and the individuals you want to have financial support when you pass away.
Beneficiaries fall into the following two main categories:
- Primary beneficiary: This is the first person in line to receive your life insurance death benefit.
- Contingent beneficiary: If the primary beneficiary dies before you or is unable to receive the payout, the funds will go to the contingent beneficiary.
What Are the Key Considerations in Choosing a Beneficiary?
The following information should be evaluated when you choose a beneficiary:
- Family dynamics: It is essential to consider family relationships and dynamics. If you have children from a previous marriage or dependents with special needs, your beneficiaries can be structured accordingly.
- Minor children: Until they reach the age of majority, minor children cannot directly receive a life insurance payout. If you have minor children you want to name as beneficiaries, a solution may be to set up a trust and name a trustee to manage the funds.
- Trusts as beneficiaries: Naming a trust as your beneficiary allows you to control how death benefits are used, even after you are gone. This may be particularly useful if you want to manage distributions over time or if your beneficiaries are minors or have special needs.
- Contingency planning: Always name a contingent beneficiary. If your primary beneficiary predeceases you or is unable to claim the death benefit, the proceeds will go to your contingent beneficiary instead of going through probate.
What Are Some Common Mistakes?
The following are common mistakes to avoid when naming beneficiaries of a life insurance policy:
- Failing to update the policy: Major life changes, such as marriage, divorce, birth, or death, should prompt a review of your beneficiary designations. If they are outdated, the death benefit could go to someone you no longer intend to support.
- Vague designations: Avoid using terms such as “my spouse” or “my children” without specifically naming each person. Legal complications can arise from ambiguity in identifying beneficiaries.
- Naming your estate: If you name your estate as the beneficiary of your policy, the proceeds must go through probate. This can delay distribution and reduce the amount your loved ones receive.
- Ignoring tax implications: If your estate is substantial and the insurance payout is included in your estate, it could push the value over the federal estate tax exemption limit, triggering significant tax liability. An effective way to avoid this is to name an Irrevocable Life Insurance Trust (ILIT) as the beneficiary to exclude life insurance proceeds from your estate for tax purposes. An ILIT allows you to control distributions and avoid estate taxes on the policy’s value.
For help with designating a beneficiary for your life insurance policy, speak with one of our helpful local agents at Van Handel Agency, Inc. to guide you in this critical estate planning issue. Give us a call today at (920) 733-1440.