Life insurance can be an important part of estate planning. To make the most of this tool, policy holders should give careful consideration to designating beneficiaries. The following provide some tips for policy holders.
Unlike many other parts of an estate plan, life insurance represents a private contract between the policy holder and the insurance company. Although a life insurance policy and a last will and testament will both be triggered by the death of the covered individual, the life insurance is not necessarily a part of the deceased person’s estate. It operates outside the will and probate process, in most circumstances. The point of life insurance is to pay a premium before death in order to ensure a certain payout to somebody after death. The person who receives the payout after death is referred to as the beneficiary.
The fact that life insurance is a private contract means that the terms of the contract will be honored regardless of certain changes in the covered person’s life. Barring exceptional circumstances, the policy will pay to the named beneficiary no matter what. This frequently poses a problem where a policy holder has previously designated one beneficiary and forgets that the policy is in place. For example: many people pass away without cancelling a previous designation of an ex-spouse.
Some life insurance policies last for years or even decades, but there is no requirement that the insurance company limit the length of the designation period. A policy holder who buys the policy early in life naming a current spouse to receive the proceeds of the policy and then gets divorced later in life might inadvertently neglect to change the beneficiary. In such a case, the ex-spouse collects the insurance. The potential for strife and anguish for a new spouse or family members is obvious. Therefore, rule number one of designating life insurance beneficiaries is to periodically revisit the designation and make sure that nothing had changed.
Policy holders should also look into naming a contingent beneficiary. For example, a policy holder might want to name one beneficiary for the insurance, but if that person has already passed away, then to a different person. The way to do that is through contingent beneficiaries. If the policy holder only names the first person, then the insurance payout will go to that person’s estate. Unless the policy holder knows the person and knows exactly how the beneficiary has decided to dispose of his or her estate, there is no control over where the insurance payout goes. Imagine a policy holder who wants to provide for a spouse first, and for two grandchildren if the spouse has passed away.
Imagine also that the spouse’s will decides to give the entire estate to a charitable trust. If the insurance goes to the spouses estate, the insurance payment will inure to the benefit of the charitable trust, and none of it will go to the grandchildren. By naming a contingent beneficiary, the policy holder can establish that the money goes first to the spouse and then to the grandchildren, regardless of the spouse’s will. The process will vary based on the insurance company, but generally naming a contingent beneficiary will be as simple as writing “Jane Smith, if living… Otherwise, John Jones and Cindy Jones.”
Finally, prior to designating beneficiaries for life insurance, think about whether the beneficiaries are minors and whether you want a large amount of cashing going to them before they reach adulthood. The rules will vary from state to state, but it would be worth a small up front cost to have an estate planner establish a trust for those underage children and the policy holder can then name the trust as the beneficiary, preventing the transfer of money to the children (and the potential that family members will end up fighting over who gets to “help” the children take care of all that money.)
A little research and periodic review of beneficiary designations can help make sure that life insurance provides for the people that the policy holder wants to make sure are taken care of after the death of the covered person. By carefully considering contingent beneficiaries and using trusts, the insurance money will avoid being fought over in probate and provide financial security to the beneficiaries.