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 So if that is out of date, the money may go to someone unexpected, regardless of your wishes in your will.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.