Life Insurance is usually procured with someone else in mind, and that someone is usually named as the beneficiary. Today’s essay will deal with some of the more important considerations when naming beneficiaries.
There are different classes of beneficiaries, and each class can have more than one beneficiary. The first class is primary, and it is this person (or people, or business, or charity) that is first in line to receive the proceeds.
If more than one primary beneficiary is named, the percentage each is to receive must be specified. It can be equal, but it is not required to be. If no percentage is specified, the proceeds will be distributed equally amongst all beneficiaries in the class.
The second class is contingent beneficiaries, and members of this class will only receive proceeds if there is no primary beneficiary. For example, if the primary beneficiary pre-deceases the insured, the contingent beneficiary would receive the proceeds.
A beneficiary need not be named specifically, although doing so can remove potential ambiguity. For example, while “in equal shares to the insured’s children” sounds straightforward, potential problems arise with a designation such as that.
First, what happens if one child pre-deceases the insured? Does that child’s share of the proceeds go to his children or his siblings? That can be rectified by specifying if the distribution is to be per stirpes (to the deceased beneficiary’s children) or per capita (to the deceased beneficiary’s siblings).
That does not preclude, however, someone coming forward saying that he is a child born out of wedlock. For these reasons, it is best, if possible, to specifically identify all beneficiaries.
The law states that beneficiaries cannot profit from their own wrong doing, so in the not so common case where a beneficiary murders the insured of a policy in which the murderer is the beneficiary, the murderer is ineligible to receive the proceeds.
In the common case of a husband and wife each procuring a policy, the other person will almost always be named as the beneficiary. The urge to name the couple’s children as contingent beneficiaries should be avoided, as minor children are not eligible to collect life insurance proceeds directly, even if they are the rightful heirs. If this situation isn’t dealt with in the couple’s wills, the courts will appoint an administrator to manage the money and to turn it over to the child(ren) upon reaching the age of majority, usually 18.
The beneficiary of a life insurance policy has an advantage over the beneficiary of a will, in that insurance proceeds pass outside of probate, i.e., regardless of what the will stipulates, the beneficiary named in the insurance policy will receive those proceeds.
In the majority of cases, the insured owns the policy. In the not so uncommon cases where the insured doesn’t own the policy, it is important that the owner also be the beneficiary. The IRS has ruled in Goodman v. Commissioner of the Internal Revenue Service that in cases where the owner, insured and beneficiary are three different people, the owner is treated as having made a taxable gift of the full death proceeds to the beneficiary.
So when I buy a policy on my new granddaughter, I will name my son as the owner and beneficiary, thus avoiding the Goodman Rule.
Generally, the naming of a beneficiary on a life insurance policy is pretty straightforward, but there are some potential pitfalls that a little education and planning can avoid.