Most people don’t put much thought into choosing a beneficiary for life insurance. Unfortunately, this can create a major problem for your heirs. As a result, TermLife2Go put together this article to help our clients choose the best beneficiary for receiving his or her life insurance proceeds.
Choosing a beneficiary for life insurance
In most cases life insurance proceeds are a non-taxable event. However, life insurance may be subject to estate taxes if the life insurance pushes your estate over the current federal exemption of $5.43 million in 2015 or over your current state exemption level, which varies state to state. This is important for those who have larger estates that exceed the exemption level. If you happen to fall into this category, please seek out advice from a financial planner and an estate planning attorney on how you can structure your life insurance to benefit your estate and not add additional taxable assets.
Now for those of us whose estates fall below the current exemption level of$ 5.43 million or $10.86 million for a married couple, there are several factors that still need to be considered when choosing a beneficiary for life insurance.
Three levels of beneficiaries for life insurance
You can name up to three levels of beneficiaries for life insurance. The first level of beneficiary is called the primary beneficiary. This beneficiary will receive all the proceeds of the life insurance. However, if the primary happens to predecease you, then the proceeds will flow to the contingent beneficiary. Likewise, if the contingent beneficiary predeceased you as well, then a third beneficiary, called the tertiary beneficiary, will receive the proceeds.
The typical beneficiary of life insurance
Most often when choosing a beneficiary for life insurance the beneficiary of life insurance proceeds is the deceased’s spouse. And the second most common beneficiary is the deceased’s children. These are the most common beneficiaries. However, naming a child as a beneficiary can create some problems and require court interaction if you have not planned ahead.
Naming a minor as your life insurance beneficiary
When you name a minor as a beneficiary you need to be aware that the minor will not be able to receive the proceeds until the minor reaches 18 years of age. In the mean time, the funds from the insurance will be placed into a trust account to be managed by a guardian. If you have not made a decision in advance on who will be the guardian of your child then the court will assign a guardian or conservator on your child’s behalf.
The best way to avoid having unnecessary court interaction is to create a will that designates in advance who the guardian of your child will be. You can also create a Living Trust or Family Trust that names the trustee of your estate. The guardian will have custody of your child and the trustee will have control over the money in your estate. The trustee will then be authorized by your trust on how to take care of your child. You can name the same person as guardian and trustee or you can assign different people to these positions. The advantage of assigning different people to act is that there are more checks and balances, forcing the guardian to be accountable for how money is spent and vice versa.
Designating your Trust as the Beneficiary of your Life Insurance
A great route to take when deciding on who should receive the proceeds of your life insurance is designating your living trust as the contingent beneficiary of the life insurance with your spouse as the primary. This is typically done by naming the current acting trustee of the trust as the beneficiary. In doing so, your life insurance proceeds will flow, first to your spouse, and then into your trust upon your death if your spouse predeceased you. The life insurance will then be distributed according to the terms of your trust. Therefore, your trust controls how the funds are distributed and you do not have to worry about trying to create an equal distribution of your estate among your children because your trust has already been set up to do so.
Another advantage besides an equal distribution according to the terms of your trust is that you can also designate in your trust at what age your children will receive the trust proceeds. With a will or with life insurance your beneficiary will typically receive the full inheritance at age 18. That means your child or children will be running around at 18 with essentially a blank check. That is not the best plan if you truly care about your child’s future. Instead, your trust can determine the age or ages that distribution will occur.
For example, a trust can be set up so that your beneficiary receives a portion at age 22, 25, and the remainder at 30. This way your beneficiary can learn some valuable life lessons. They might blow through the money they received at 22 but by the next distribution they will have (hopefully) learned that they need to take better care of their inheritance.
Naming your estate as the beneficiary
If you leave your life insurance to your estate you could be inviting a world of hurt to your heirs. The problem is different states have different rules when it comes to what asset level an estate must have in order to be required to enter into probate. And probate can be costly. In some states, probate can cost your estate 4-6% of the estates total assets. This is due to the fact that attorney fees, CPAs, and appraisal fees take a huge amount of the estate assets.
For example, in California the threshold for a probate of an estate is $150,000. That means that if your estate has assets in excess of $150,000, your estate will go through probate. And in California, the fair market value of the home and not the net value of the home is what the court considers. That means if your home is worth $250,000 but the net value (home value – mortgage) is only $25,000, the home will still be worth $250,000. As a result, you would be subject to probate and the accompanying fees even though your actual net worth in the home is only $25,000.
The good news when it comes to life insurance is that it is generally considered a non probate asset. The funds from the life insurance will go directly to your beneficiary named in your life insurance policy. But if you leave the funds to your estate then the estate may be forced into a costly probate, taking a lot of the assets away from your heirs and giving it to attorneys, accountants, and appraisers. The better route to take is to name your spouse and trust as beneficiary or your spouse and kids. Don’t however name your estate as the beneficiary as this can cause all sorts of money issues.
Life insurance beneficiary and second marriages
If you are in a new marriage and you have kids from your previous marriage then you may want to list your kids as the primary beneficiaries. The best way to do this is to set up a trust that will take care of the money while your kids are minors. You can research a Qualified Terminable Interest Property Trust for more information. Otherwise, your new spouse may not be so inclined to share with your kids upon your passing.
Naming a business partner as your beneficiary of your life insurance
Another way that life insurance can be used as a great estate planning tool is by naming your business partner as the beneficiary. Business owner life insurance is a great way to make sure your business continues in the event of your untimely death. For more on Business Owner Life Insurance see: Using Life Insurance to Cover an SBA Loan; Key Man Life Insurance; Funding a Buy-Sell Agreement with Life Insurance.
Naming a charity as the beneficiary of your life insurance
If your are single or if you desire your assets go to a charity, then a great way to accomplish this is to name a charity as the beneficiary of your life insurance.
When a beneficiary is frowned upon by a life insurance company
The main ingredient that a life insurance underwriter is looking for when reviewing a life insurance beneficiary is insurable interest. An insurable interest exists when there is a financial loss to the beneficiary. A life insurance company will look into whether the beneficiary has an insurable interest in the life of the proposed insured. If there is no insurable interest the life insurance company may choose not to offer insurance.
An example of an insurable interest is a husband or wife who is the primary bread winner. If the primary bread winner were to die, the family he or she leaves behind would suffer a direct financial loss. Thus, the beneficiary of the husband or wife has an insurable interest.
An example where no insurable interest exists is when someone wants to leave money behind to a friend. If the primary insured dies, there is no economic loss to the friend. A life insurance company might choose to deny life insurance in this case due to the outside chance that some sort of harmful act could occur, such as the friend deciding to murder the primary insured.
Your life insurance beneficiary is not set in stone
You can always change the beneficiary of your life insurance. The exception to this would be if you set up an irrevocable life insurance trust. As the primary insured and Settlor of the ILIT, you would not want to grant yourself the ability to make changes to the Irrevocable Trust. This could cause some serious consequences to the validity of the irrevocable life insurance trust. There are work around to this and a good estate planning attorney would be able to instruct you of all the potential pitfalls. But apart from an ILIT, the person who you name the beneficiary today does not have to be the person who becomes the beneficiary down the road.
One word of caution though. There have been cases where a beneficiary has been deemed to not have an insurable interest and the life insurance proceeds went to a different party than the beneficiary listed upon the death of the insured. The key would be that if you decide to change the beneficiary of your life insurance, make sure the beneficiary has some sort of insurable interest. Otherwise, there may be potential for a family member to attack the validity of the beneficiary in court.
Why would a court allow this? The main reason a court might invalidate a beneficiary would be where there is a question of undue influence or duress. An example might be an older man who removes his children as beneficiaries in favor of his care taker.
Life events that signal a need to update your beneficiary
There are certain life events that require you to take action and make sure your life insurance beneficiary is up to date. These life events include divorce, remarriage, the birth of a new child, and the death of a child.
What if my life insurance beneficiary takes my life?
In the horrible event that your life insurance beneficiary decides to take your life in order to collect on the life insurance proceeds, the law is pretty straightforward that the beneficiary who murdered the primary insured, as well as any conspirators, would not be able to collect.
The Bottom Line
The main point of all this is that TermLife2Go knows a lot about beneficiary designations and life insurance. We are here to answer any questions you may have. Our goal is to provide you with service second to none.
TermLife2go is an agency that works with dozens of the top rated best life insurance companies. Our #1 priority is to find you the best company at the best price…for you! That means we tailor a policy specifically to you because no two clients are alike. Let us leverage our expertise for you and see if we can’t save you thousands of dollars on life insurance.
We do not favor one life insurance company over another. Instead, we find out what you need and then we recommend the lowest priced, best life insurance company to meet your specific need. Therefore, if price matters to you, give us a chance to earn your business. We are here to serve you!
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