What is a beneficiary?
A beneficiary is a person or organization that has been named to receive property, especially a trust, will, or life insurance policy, belonging to another individual in the event of their death. A contingent beneficiary, or secondary beneficiary, serves as a backup to the primary beneficiaries named on your life insurance policy. When you pass away, if all of your primary beneficiaries have also passed away, your contingent beneficiaries will receive the payout.
Life insurance proceeds are tax free to the beneficiary and are not reported as gross income. However, any interest received or accrued is taxable. Life insurance beneficiaries can be individuals, such as a spouse or adult child, or entities, such as a trust. For example, if you have minor children, you may choose to establish a trust and name it as the beneficiary of your life insurance policy. If you were to pass away, then the policy’s death benefit would be paid to the trust. The trustee would then manage those assets according to the terms of the trust on behalf of its beneficiaries (e.g., your children).
How difficult is it to designate a beneficiary?
Designating beneficiaries for your financial accounts involves providing the names, social security numbers and perhaps other specifics on a form when you open your account. If your accounts have been opened, simply request the appropriate form(s) for designating beneficiaries, fill it out carefully and properly, and return it to your financial institution.
Who can change the beneficiary on a life insurance policy?
In the case of a life insurance policy that has one or more revocable beneficiaries, the owner of the policy can change the beneficiary designations at any time. This is something that may be necessary if a beneficiary passes away or if the primary beneficiary is a spouse and the marriage ends in divorce.
If irrevocable beneficiaries are named to a life insurance policy, then the policy owner would need the consent of the beneficiary and any contingent beneficiaries to make a change. For that reason, it’s important to think carefully when choosing policy beneficiaries.
Pros and cons of designating a minor child as a beneficiary.
If you’re a parent, you should know that it’s possible to name a minor as your primary beneficiary, depending on your insurance company. But there may be some legal implications. Typically, an insurer won’t simply give your minor child the death benefit when you pass away. Instead, the court will likely need to appoint an adult custodian to manage the funds until the child becomes an adult. Unfortunately, this can be an expensive, time-consuming process.
If you do go this route, your child will eventually be able to use the death benefit as they need to. Once the funds are transferred to them, upon turning 18 or 21 depending which state you reside in, they can use it to help pay for health insurance, college, or everyday expenses. This can give them the financial help they need once they become a young adult.
If you determine it doesn’t make sense to name your child as a beneficiary, consider these alternative options:
- Establish a trust – With a trust, you’ll have more control because you’ll be able to specify how you’d like your death benefit to be distributed. For instance, you may state that a portion of the funds be distributed for your child’s college when they turn 18, and then at age 25, they can receive the remaining amount to use in any way they wish.
- Designate your partner as a beneficiary – If you can, consider assigning your spouse or partner as the primary beneficiary. This way, they can continue to handle your household finances and save money for your child’s future. If both you and your partner pass away, the trust can kick in.
- Create a UTMA account – The Uniform Transfers to Minors Act (UTMA) requires you to name a custodian to manage your child’s assets until they become an adult. Then, the assets will be transferred to your adult child, who may use the funds in any way they choose.
What happens if I don’t choose a beneficiary?
If you don’t choose one or more beneficiaries for your assets, then the decision about what happens to your assets will be made by someone such as a financial institution or a court in the state where you reside.
The bottom line…
If you care about the distribution of your financial assets after you’re gone, then choosing beneficiaries for your financial accounts should be a priority. By designating beneficiaries, you can ensure that your property ends up in the right hands.