Common Life Insurance Beneficiary Naming Mistakes

Common Beneficiary Naming Mistakes

Common Beneficiary Naming Mistakes

Naming a beneficiary for your life insurance policy and your last will and testament is one of the most important decisions in your life. For many people it is straightforward, for others with complex family situations in can be very difficult. Even for those with a close knit family, naming the wrong beneficiary can lead to hurt feelings and family squabbles after you pass away.

The last thing you want to do is create a mess for your family to clean up after you depart, which can potentially ruin their relationship with each other. So let’s take a look at the most common mistakes people make when naming their beneficiary.

Pushing people into a tax trap

Life insurance is tax free except when different people are playing the role of policy owner, the insured and the beneficiary. So for example if your uncle takes out a life insurance policy on your grandfather and you are named as the beneficiary, then the money could be declared a taxable gift. You could land the person with a substantial tax bill and run into financial problems at a later date if that is not fully understood.

The best way to avoid this is to make sure that the insured party also owns the policy and you will avoid paying any tax on the sum.

Believing your will determines who gets the life insurance money

The life insurance policy operates separately to any will you might have drawn. So that means any declaration in your will saying that the life insurance money should be split a certain way is irrelevant. The life insurance policy only uses the beneficiary list to determine who will get the money. So if that is out of date, the money may go to someone unexpected, regardless of your wishes in your will.

Not keeping the beneficiary up to date

Many people don’t keep their beneficiary list up to date. You might get divorced and have your first wife listed as a beneficiary, or your beneficiary might die, or you might have a falling out with your beneficiary. If you do not update the policy, your relatives might get a nasty shock when they realize they won’t see any of the money.

Skimping on details

If you wish to have a somewhat complex arrangement with your life insurance beneficiary list, make sure it is detailed very closely.

Say for example if you want 5 grandchildren and 3 children to take an equal share in the policy, how do you stipulate that without any doubt?

The two methods are per stirpes and per capita. Per stirpes means that the proceeds are divided by branch of the family and per capita means that it is done on a per head basis.

So in the example above of 5 grandchildren and 3 adult children, one of your adult children may be responsible for 3 grandchildren and the other 2 adults may be responsible for 1 grandchild each.

Now if you did it on a Per stirpes basis, the three children would receive an equal amount each because it is following the branch of the family. So the adult with 3 children gets the same as the adult with 1 child. You may see that as fair.

If you did it on a per capita basis, the adult with 3 children is getting 4 shares, while the adults with 1 child get 2 shares of the policy dividend. Is that more equitable or less equitable? You have to also consider other circumstances of the children involved, are they all well off, or are some struggling more.

Also, what happens should one of the children or grandchildren pass away? Sometimes complex and precise documents should be lodged when dealing with beneficiaries and an estate lawyer might be required.

Forgetting to tell people you have a life insurance policy!

It happens quite a bit – the family doesn’t realise the relative doesn’t have a life insurance policy, where it is and who the beneficiary is. Sometimes a benefit is never claimed and hundreds of thousands of dollars are lost to the family because the deceased never told them about the policy. Make sure your family knows about the policy and the beneficiary.

Giving money to young people without stipulations

When you name a young person as a beneficiary, often they aren’t equipped with the skills and life experience required to spend wisely. If an 18 year old suddenly inherits $1 million dollars, their first thought may not be about investing it intelligently, it might be about getting a sportscar.

You could even send them on a destructive path of partying and binging on drugs and alcohol or set them up to be fleeced by someone unscrupulous. Some people set up trusts so that the young person can obtain some spending money to make their life more comfortable, to help them with a home deposit but they don’t receive unfettered access until they are older. Sometimes trusts have requirements, so if the young person finishes college they get a set amount early as a reward.

Naming only 1 beneficiary

You may think that a certain member of your family is smart enough to handle all of the funds from the life insurance policy and hand out money to the other relatives. But after you are gone, their attitude may change, they might have a falling out with another relative or other relatives may resent them being named as sole beneficiary.

It is often a mistake to place a great deal of trust in the hands of a sole beneficiary, and it’s better to make your intentions for the money known by having multiple beneficiaries.

Additionally if you have a single beneficiary, if something happens to them, then the policy may be in chaos. If you pass away in a car accident and your sole beneficiary is in the car with you and passes away, you could be leaving your family in chaos. If you do not make up more complex arrangements for beneficiaries, at the very least you should have a secondary and final beneficiary listed.

Naming a minor as a beneficiary

Some people have a favorite grandchild who they want to see succeed in life, so think it may be a great idea to name them as a beneficiary. The problem here is that life insurance companies will not pay a minor when you pass away. A guardian will need to be appointed and that may be someone you don’t trust with the money, or someone you don’t like. Instead, you should find an adult who you know is trustworthy and is able to safeguard the money until the minor reaches adulthood and can claim it (at 18 or 21 depending on the location).

Making a beneficiary lose their welfare entitlements

If you have a beneficiary who is receiving government entitlements like some with a disability, they may lose that when they receive the money from the life insurance policy. The amount they can receive is shockingly low, with anyone who receives more than $2000 inheritance disqualified for medicaid and supplemental security income. In this situation you need to setup a trust which will manage the money in a way that helps the person in the long term and doesn’t dramatically affect their welfare entitlements if possible.

Naming An Insurance Beneficiary

Insurance Beneficiaries

Insurance Beneficiaries

After all of the work you may have gone through in finding the right insurance policy to suit your circumstances, you might think that most of the work is done.  Well not quite, you are still to face what can be one of the hardest decisions in your life – determining who will be the beneficiaries of your life insurance policies.  The beneficiary is the person named in your life insurance policy as the one to receive the payout after you die.  You can also name multiple beneficiaries and split the proceeds of the life insurance in any way you choose fit.  There are some limitations as yo who you can select to be a beneficiary, so read on to find out!

In the United States, a few states require you to choose someone who is related to you in some way. So you are required to choose a child, spouse or other close relative.  Other states have no such stipulation so you can name any entity you can think of as a recipient of the money.  You can also name your estate as the primary beneficiary of your will, which means that the money goes into your estate and will be divided according to your will.  Just be careful if you owe money though – any money going into the estate will also be available to creditors.  Your children may not see any of the money if you have a lot of debt and don’t put them as key beneficiaries.

Additionally there are also a number of different types of life insurance beneficiaries.  Irrevocable beneficiaries can’t be changed without your consent, while revocable beneficiaries can be.  Changing beneficiaries is as simple as lodging a form with your insurance company, so be careful with who has access to your paperwork in your final days!  There are also different types of beneficiaries – primary are the main beneficiaries, secondary or contingent are the second level of beneficiaries.  So if your primary beneficiary dies before you do, the money will go to the secondary beneficiaries.  There is no limit to the number of beneficiaries you can include, so you can make a complex and detailed list as long as you also note the split of the life insurance each party receives.  Most people use simple percentages to determine which parties receive what amount as the total value of the policy changes over time.

It is crucial that you name beneficiaries specifically because in the past people have run into all sorts of problems with money going into their estate and not being distributed in the way they had intended.  Beneficiaries also receive the money from life insurance almost immediately, which avoids any costs like probate fees, that might be attached to the dividing of assets in your will.  Also remember that if you name a child as your beneficiary, they will need a guardian or a trust to handle the money until they are of suitable age.  If you don’t, the court may appoint a guardian for the child and their decisions may not be as you intended.

You should always keep your beneficiaries up to date because life changes rapidly and you might have more children, get divorced, get remarried or have a falling out with a relative.  Make sure you keep it up to date or your assets may go to some undesirable party!