Common Life Insurance Beneficiary Mistakes
Often policy holders make mistakes in naming a life insurance beneficiary. A life insurance policy is a contract – the death benefits get paid based on who the owner of the policy designates as the beneficiary or beneficiaries.
Unlike common belief, life insurance proceeds do not necessarily get paid based on the terms of a decedent’s Last Will and Testament or the decedent’s Living Trust. The proceeds get distributed simply in accordance with the terms of a completed beneficiary designation form provided by the life insurance company.
The following are common mistakes people make when naming beneficiaries of their life insurance policy:
1) Failing to Update Beneficiary Designation Form
Typically, a beneficiary is named when the policy is purchased. However, the named beneficiary may not be appropriate at a later date. As stated above, a change in a Will or Living Trust does not update the beneficiary designated under a life insurance policy. Beneficiary designations should be reviewed at least every two to three years.
2) Failing to Name a Contingent Beneficiary
People frequently just name a primary beneficiary (for example a spouse). What if your primary beneficiary is not living? In this case, the life insurance would typically be paid to the decedent’s estate, which would then expose the life insurance proceeds to probate and any debt the decedent may have upon death.
3) Naming a Young Child as a Beneficiary
It is not uncommon to see a spouse named as the primary beneficiary and children named as the contingent beneficiaries. If your spouse does not survive you and your children are minors, this could be exactly what you don’t want. Not only would thousands of dollars need to be spent to get a court-ordered guardian and conservator to manage the funds for a minor child, but a child would be entitled to the life insurance proceeds at age 18. The solution is to name a trust for your children as the contingent beneficiary. The terms of the trust would then dictate how and when the child can use the money. This is discussed in more detail in item No. 5 below.
4) Naming a Beneficiary Who is Receiving Government Benefits
If you name a person with special needs who is also receiving needs-based government benefits as the beneficiary of a life insurance policy, it could cause the beneficiary to lose his or her benefits. The solution would be to establish a Special Needs Trust (SNT) and name the SNT as the beneficiary. The SNT is drafted in a way to protect the life insurance proceeds from disqualifying the beneficiary in his or her continued governmental support.
5) Believing that a Will or Living Trust Dictates the Distribution of Life Insurance Proceeds
As stated above, the distribution of life insurance proceeds depends simply on who is designated as the beneficiary on a beneficiary designation form. If you want to regulate how the life insurance proceeds are distributed to a beneficiary, you need to create a trust for the beneficiary and name the trust as the designated beneficiary. A trust for a beneficiary can be structured in a Will or a Living Trust.
It is not uncommon for me to hear people say that “I am worth more dead than alive”. From a monetary standpoint, if this is true, it is extremely important to make sure that your beneficiary designation forms are up-to-date and completed appropriately. You are not done with your estate plan by simply signing a Will or Living Trust. You need to also make sure that your beneficiary designation forms for your life insurance (and other assets such as IRA’s, 401k’s, etc.) are filled out correctly. While it is simple to update beneficiary designation forms, it is frequently neglected. This could be a huge mistake.