Making Your Heirs Apparent: Life Insurance Beneficiaries

In the language of life insurance, a beneficiary is the recipient of the proceeds of a policy when the named insured dies. The owner of a life insurance policy has a great deal of flexibility in naming beneficiaries and can generally name anyone he or she chooses. When making beneficiary decisions, it is important to ensure that the wishes of the policyowner are fulfilled and that legal complications are avoided.

Types of Beneficiaries

Beneficiaries are typically categorized as either primary or contingent. A primary beneficiary is entitled to the proceeds of the policy upon the death of the insured, but such rights expire if he or she dies before the insured. A contingent (or secondary) beneficiary is entitled to the policy proceeds if the primary beneficiary has predeceased the insured. One fairly common arrangement might stipulate that, if a primary beneficiary dies before collecting the entire proceeds of the policy, then the remaining amount will be payable to the contingent beneficiary. It is often desirable to have several levels of contingent beneficiaries.

A beneficiary can be either specific (a person identified by name and relationship) or a class designation (a group of individuals such as the “children of the insured”). While the naming of specific beneficiaries is usually clear-cut, unintended complications can arise when designating classes of beneficiaries.

For example, if you plan to name your children as beneficiaries, you will need to clarify if you intend to include adopted children or children by a former spouse. If your children are minors, it is also important to determine if the insurance company will in fact pay the proceeds to a minor beneficiary. Generally, insurers insist on paying proceeds to a legal guardian rather than to a minor.

Consider the following hypothetical situation in which the policyowner’s intentions appear straightforward, but could become complicated. Harriet, who is seventy years old, has planned for the proceeds of her life insurance policy to be paid to her children (Sam, Carole, and Jill) or her grandchildren. Now, suppose Sam and Carole die before their mother. Sam leaves four children and Carole has no children. How will the proceeds of the policy be distributed when Harriet eventually dies?

Methods of Distribution

Per stirpes and per capita are terms that describe methods of distributing property to family members and heirs. Per stirpes means “branches of the family,” and per capita means “by heads.” In the example above, under a per stirpes distribution, Jill (one branch) would receive one-half of the proceeds and Sam’s surviving children (the other branch) would divide the remaining half among themselves. Under a per capita distribution, Sam’s four children, along with Jill, would each receive one-fifth of the proceeds. Remember, there might be complications if any of Sam’s children are still minors when Harriet dies and legal guardians have not been appointed.

Revocable vs. Irrevocable

There are also different consequences according to whether beneficiary designations are revocable or irrevocable.

If a beneficiary designation is revocable, the policyowner reserves the right to change the beneficiary. A person designated as a revocable beneficiary has only an “expectation” of benefits, since the owner of the policy can exercise any of the policy rights without the consent of the revocable beneficiary.

On the other hand, an irrevocable beneficiary designation cannot be changed without the consent of that beneficiary. While this arrangement is sometimes desirable for estate planning purposes, the legal status of an irrevocable beneficiary is uncertain. Some may regard an irrevocable beneficiary as a “co-owner” of the policy; therefore, the beneficiary’s consent is needed to exercise any policy rights. At the other extreme, others may contend that an irrevocable beneficiary’s consent is needed only for exercising a change of beneficiary.

The latter position can create the somewhat puzzling effect of having the beneficiary’s rights compromised if the policyowner exercises other rights, such as surrendering the policy or permitting it to lapse. Due to the vague legal status of an irrevocable designation, it is usually preferable to use revocable beneficiary designations.

A further complication can arise when one’s estate is named as a beneficiary of a life insurance policy. The policy proceeds may be tied up in the probate process or reduced by the claims of creditors.

The distribution desired by a policyowner must be clearly set forth in the beneficiary designation. A change in family circumstances after a policy is initially written, such as a divorce, could leave you with unintended beneficiaries, so it is important to review your insurance policies whenever such changes occur. If you are unsure about your beneficiary designations, check your policies, and take the steps necessary to make any appropriate changes. Your family will be sure to appreciate your thoughtfulness.

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