In the language of life insurance, a beneficiary is the recipient of the proceeds of a policy when the named insured person 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. However, it is important to understand the different types of designations and methods of distribution before choosing your beneficiaries.
Types of Beneficiaries
Beneficiaries are typically categorized as either primary or contingent. A primary beneficiary is entitled to the benefits of the policy on 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 benefits if the primary beneficiary has predeceased the insured. One fairly common arrangement stipulates that, if a primary beneficiary dies before the insured, then the benefits of the policy would be payable to the contingent beneficiary. You may want to have several contingent beneficiaries.
A beneficiary can be designated as a specific beneficiary (a person identified by name and relationship) or a class beneficiary (a group of individuals such as “children of the insured”). While the naming of specific beneficiaries is usually clear, unintended complications can arise when designating classes of beneficiaries.
For example, if you plan to name your children as beneficiaries, you must clarify if you intend to include adopted children or children by a former spouse. If your children are minors, you need to learn whether the insurance company pays benefits to a minor beneficiary. Typically, insurers pay benefits to a legal guardian rather than to a minor.
Let’s look at a scenario in which the policy owner’s intentions appear straightforward, but could become complicated. Bonnie, age 70, has planned for the benefits of her life insurance policy to be paid to her children (David, Michelle, and Joanna) or her grandchildren. Now, suppose David and Joanna die before their mother. David leaves four children and Joanna has no children. How will the proceeds of the policy be distributed when Bonnie 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, Michelle (one branch) would receive one-half of the proceeds and David’s surviving children (the other branch) would divide the remaining half among themselves. Under a per capita distribution, David’s four children, along with Michelle, would each receive one-fifth of the proceeds. Remember, if any of David’s children are still minors when Bonnie dies and legal guardians have not been appointed, there may be complications.
Revocable vs. Irrevocable
Consequences may also vary 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. 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 situation of compromising the beneficiary’s rights if the policyowner exercises other rights, such as surrendering the policy or permitting it to lapse. Due to the serious implications of an irrevocable designation, it is often preferable to use a revocable beneficiary designation.
A further complication can arise when one’s estate is named as a beneficiary of a life insurance policy. The policy benefits may be tied up in the probate process or reduced by the claims of creditors.
The distribution desired by the 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 unintended beneficiaries, so it is important to review your insurance policies regularly. If you are unsure about your beneficiary designations, check your policies, and take the steps necessary to make appropriate changes.