Top 11 Mistakes To Avoid When Picking Life Insurance Beneficiaries


Comic Strip

A life insurance policy is a great way to financially protect your loved ones after your death. We all want to grow old with our loved ones and live our lives to the fullest.

However, life’s unpredictable.

And that’s precisely why you must prepare yourself so that your family is protected and won’t have the added financial stress that often comes from an unexpected death.

On its face, picking a life insurance beneficiary seems simple. And it usually is. But it can be quite tricky at times.

When it comes to naming a life insurance beneficiary, I’ve seen tons of brilliant people make some elementary mistakes. These basic mistakes can create significant problems for your family after your death.

When it comes to naming a life insurance beneficiary, I’ve seen tons of brilliant people make some elementary mistakes. These basic mistakes can create significant problems for your family after your death.

James Long, Regnum Legal

It is exceedingly important for you to avoid these mistakes so that your family and your legacy is protected.

And that’s what we will be taking a look at here. I will tell you the top 11 mistakes you should avoid when choosing a life insurance beneficiary.

Well, then!

Let’s dive in.

Top 11 Mistakes to Avoid When Picking Your Life Insurance Beneficiaries

Here are my top 11 mistakes when naming beneficiaries for your life insurance policy:

1.                Naming a minor as a beneficiary.

2.                Allowing certain beneficiaries to get insurance proceeds without conditions.

3.                Assuming that the designations in your estate plan will control your life insurance policy.

4.                Making a dependent ineligible for government benefits.

5.                Being too general.

6.                Overlooking a spouse in a community property state.

7.                Gift-tax traps.

8.                Failing to name a contingent beneficiary.

9.                Forgetting to update your beneficiary designation after a divorce.

10.           Unintentionally disinheriting a beneficiary.

11.           Naming your estate as your life insurance policy’s beneficiary.

Naming Minor As Beneficiary

Most life insurance companies will not pay a death benefit to a minor directly. There will usually need to be someone who oversees the funds on behalf of the minor.

That’s because, depending on the benefit amount, a huge payout in the hands of a minor child at such a young age can turn out to be poisonous (metaphorically.)

The chances are that your child wastes the money, uses it to develop (or encourage) ill advised/illegal activities, or gets taken advantage of by adult swindlers. Therefore, to make sure that your child/children do not fall victim to themselves or other unscrupulous people, life insurance companies don’t pay the proceeds to the minors directly.

To prevent these kinds of risks, you need to engage in proper estate planning. For example, you can create a living trust and then name the trust as a designated beneficiary. This will allow you to set the terms for how and when your children receive the trust proceeds. It will also allow you to set other conditions, like graduating from college.

If you don’t have proper estate planning, the court will be forced to appoint a legal guardian who will be responsible for handling the proceeds until your child/children turn 18 (depending on your state laws).

Going through this process can be expensive, time-consuming, and frustrating.

Allowing Beneficiaries To Get Proceeds Without Conditions

Even if you do not have a minor as the primary beneficiary of your policy, it is still vital to set conditions on how the money is dispersed.

Again, depending on the death benefit, you may want to place conditions on the payout proceeds. For example, if your beneficiary is 21, do you really want he/she to have access to a large sum of money on their way to Vegas? Will having access to a large sum of money demotivate your son/daughter from graduating from University or discourage them from otherwise engaging in productive and lucrative work?

At the end of the day, only you understand the answers to these questions. If you want your policy to help your kids have a good time, and to let them buy a round of drinks for their friends on their 21st birthday, hey, no judgments here. But when filling out a beneficiary designation form, you need to ask yourself at least these basic questions:

1. What is the money for?

2. How do I want the beneficiary to use it?

3. Is there anything I DO NOT want my beneficiary to use the money for?

Only you can answer these questions, but you need to answer them.

If you want to have greater control of how the proceeds are spent, by whom they are spent, and when they are spent, a living trust can help you accomplish these goals.

Assuming That Your Estate Plan Trumps Your Life Insurance Policy

Similar to a life insurance policy, a living trust plays a significant role in securing your family’s financial future. Both will play a critical role once you’re gone. I have had clients in the past express to me their surprise that they need to update their designated beneficiary for their life insurance policy during the estate planning process.

I have even had a client who’s husband mistakenly forgot to update his beneficiary designation form after his divorce. Then following his death, my client (his wife) was surprised that her deceased husband’s ex-wife received all of the life insurance proceeds.

Before death, he amended his trust to omit his ex-wife and add his current wife but failed to update his primary beneficiary. He mistakenly thought that his trust would control who gets the life insurance payout. He was wrong.

Your life insurance benefit goes to your life insurance beneficiaries. The life insurance company DOES NOT CARE who is named in your trust. It only cares about who you listed as the primary beneficiary on the beneficiary designation form.

But, there is a way to harmonize your life insurance policy with your living trust. All you have to do is name your living test as the primary beneficiary of the life insurance proceeds. Then when you pass-on, the insurance company will pay the proceeds to the trust, and your living trust will then control how the proceeds are divided and used.

Regardless of what you choose to do, please understand this one point: the insurance company will pay the death benefit to whoever you have listed as the primary beneficiary on the beneficiary designation form. So if you have not updated your designation form in a while, you should get in touch with your insurer to make any changes, if needed.

Making A Dependent Ineligible For Government Benefits

Often parents with good hearts what to have a life insurance policy to help a child with special needs. At times, other family members may also name a relative with special needs as a beneficiary for their life insurance policy to help them with living expenses after they are gone.

But, naming a person with special needs as a life insurance beneficiary needs to be done with great care.

There are so many government programs to assist persons with all kinds of disabilities and special needs. Most, if not all, of them, have a maximum income thresholds. This means that if a person with a disability or a special needs has assets over the threshold limit, they cannot qualify for government benefits. Worse, if a person who previously qualified for government benefits receives a large inheritance or death benefit, he or she will be kicked off of the government benefit, and the government will try to take the inheritance or life insurance payout as reimbursement.

Generally, anybody receiving inheritance or gift exceeding $2,000 of value is disqualified for the Supplemental Security Income & Medicaid, subject to the Federal Law.[i]

Therefore, if you are considering naming anyone with a disability or special needs as a beneficiary of your life insurance policy, stop. Consult a qualified estate planning attorney. What you should do is set up a special needs trust, and then name the special needs trust as the beneficiary. If you live in California, I do special needs trusts for families in these situations through my private law firm called “Regnum Legacy.” Additionally, the California Department of Health Care Services has a referral program, and they can refer you to qualified estate planning attorneys who can help you.

Being Too General

Generally (pun intended), being too general will not be a problem. Most people name specific individuals as their life insurance beneficiaries. But it happens on occasion that people want to list particular charities or organizations as their beneficiaries. Let’s say you want to give life insurance proceeds to your local Catholic church, St. Paul. Well, this is likely not specific enough. (I just googled “St. Pauls” and 12 different churches came up in my local area).

Instead, you should be as specific as possible. You should say the name of the charity and the address. If the charity is a church, add the denomination (if applicable). This way, a life insurance company can distinguish between St Paul’s Catholic Church and St. Paul’s Lutheran Church. Additionally, you should try to get the tax-id of the charity or church (the Tax-Id is like a social security number for a business or charity).

Most insurance carriers avoid this problem by requiring very specific content when you are naming a beneficiary.

Overlooking A Spouse In A Community Property State

So, this is not necessarily a mistake, but it does involve a few more loopholes. You can (mostly) name anyone to be your life insurance beneficiary. You can have multiple beneficiaries. You can have contingent beneficiaries. You can even get really specific and have a tertiary beneficiary.

But if you live in a community property state, your spouse would be required to sign a form in order to waive the rights to the money in case you name someone else as your life insurance beneficiary.

Here’s the list of the community property states:

  • Wisconsin    
  • Washington
  • Arizona
  • California
  • Louisiana
  • Idaho
  • Texas
  • New Mexico
  • Nevada

So if you live in one of these states, and you DO NOT want your spouse to be your life insurance beneficiary, you will likely need to fill out additional paperwork and obtain your spouse’s consent.

Gift-Tax Traps

You might fall into a tax trap.

Every insurance policy has three main parties. First is the policy owner. That is the person who purchases the policy from the insurance company. Second is the “insured.” That is the person who’s life is being insured. Finally, there is the beneficiary. You guessed it. The beneficiary is the person who gets the death benefit at the insured’s death.

Usually, death benefits are tax-free.

However, that’s not the case when there are three different people playing the role of the policy owner, insured, and beneficiary.

In such cases, on the insured’s death, the death benefit will be taxable.

A common example is when you purchase a policy on your spouse’s life and name your children as the beneficiary. In these cases, the death benefit is fully taxable as a gift to the beneficiary (subject to gift tax limitations). You could get around this by purchasing a policy on your own life or naming yourself a the beneficiary.

Failing To Name A Contingent Beneficiary

You need a back-up, i.e., you need to name a contingent beneficiary.

It is not enough to name your spouse or children as the beneficiary on your policy. If your beneficiary dies before you, or you die together, then the insurance company will not have any named person to distribute the life insurance proceeds to. Therefore, the intestate succession laws will likely control how your policy gets distributed. And you may not like who gets the money.

To solve this problem, just name a contingent beneficiary. A contingent beneficiary is a person (or persons) you name to receive life insurance proceeds if the primary beneficiary dies before you.

Thousands of people fail to name a contingent beneficiary and risk (believe it or not) their mother-in-law receiving their life insurance proceeds.

If you would like to know more about intestate succession and learn how your mother-in-law could inherit your estate, check out our article, HERE.

But avoid all this a just name a contingent beneficiary.

Forgetting To Update Your Beneficiary Designation After A Divorce

You may recall my client’s husband from a few paragraphs ago. The one who obtained a life insurance policy named his (then), current wife, as the primary beneficiary, then got a divorce and forgot to name my client (his new wife) as the primary beneficiary. Remember him? If you do, I’m sure you remember the result too. The ex-wife got the life insurance proceeds.

It’s imperative for anybody to review their policy regularly and make sure that the people you list as the primary beneficiary on your policy are still correct. This is especially true after a divorce or other major life events.

You need to change the beneficiaries as often as your circumstances change.

Unintentionally Disinheriting A Beneficiary

It can happen. You really need to know the difference between “per stirpes” and “per capita” distributions. I have two in-depth articles about this if you are interested, you can read: “Per Stirpes and Pro Rata: What’s the Difference” or “Per Stirpes Definition with Infographic, Charts, and Examples.”

For now, just understand that “per stripes” allows a beneficiary’s children to inherit that beneficiary’s share. So, if you name your two children as your primary beneficiaries and one dies before you, then whether or not your grandkids can get their deceased parent’s share of your life insurance proceeds depends on whether you used the words “per stirpes” or “by representation” (which means the same thing).

If you did not say in the beneficiary designation that your beneficiary’s had their right “per stirpes,” then you may unintentionally disinherit your grandkids from their parents’ estate.

Of course, that may be fine with you. And that is ok (unless you’re my grandma).

Just know that if you want your beneficiary’s children to be able to receive their parent’s share of the policy benefits, you need to say “per stirpes” or “by right of representation” on the designation form. Again, this can be complicated, so check out the two articles above  if you need additional information.

Naming Your Estate As Your Life Insurance Policy’s Beneficiary

What if you name your estate as your life insurance policy’s beneficiary? BAD THINGS WILL HAPPEN!

You may be thinking, “But wait, didn’t you just tell me to name my trust as the beneficiary?”

Yes, I did.

Your trust is not the same as your estate.

You SHOULD name your trust as a beneficiary (if appropriate for your situation). But you SHOULD NOT name your estate.

Anything in your estate is going to have to go through the probate process. A trust is an estate planning tool that you put your assets into prior to your death so that when you die, your estate does not own the assets. Instead, your trust owns the assets. As you may know, assets owned by a trust do not have to go through probate.

So what’s the big deal?

First, probate is long and expensive. Check out my article “What is Probate and Why Avoid It” to learn why probate is a bad place to be.

Secondly, apart from the time and expense, all assets in probate are subject to the claims of creditors. This means that if you name your estate as the beneficiary, your creditors will has first “dibs” at your life insurance proceeds.

Conclusion

It’s essential for everyone to review their life insurance policy and beneficiary designations regularly. And if you have recently been through a significant event in your life, like marriage, divorce, having children, death of one of your beneficiaries, it’s vital to revise your life insurance policy and beneficiary designations straight away.

In the end, it’s about what’s best for your loved ones. Death is an emotional and painful process for the loved ones you leave behind. The last thing they need are additional headaches.

If you live in California and need additional guidance, do not hesitate to reach out to me through my private firm: www.regnumlegacy.com.


[i] https://www.alrp.org/wp-content/uploads/Will-My-Inheritance-Ruin-My-SSI-Medi-Cal.pdf

James Long, JD

James earned his Juris Doctorate in 2010 and was later appointed to serve as an Expert for the Vatican at the United Nations. James is the former Managing Editor of the University of St. Thomas Journal of Law and Public Policy, and an Associate Editor of the St. Thomas Law Journal. James is currently a business lawyer, litigator, and estate planner with nine years' experience helping families and businesses succeed.

Recent Posts