Avoid These Life Insurance Beneficiary Mistakes
Life insurance serves as a critical financial safety net for your loved ones after you pass away. Although selecting beneficiaries might seem straightforward, a number of complex scenarios can unexpectedly complicate matters. Here are six key pitfalls you should steer clear of when naming life insurance beneficiaries.
The Pitfall of Not Designating Any Beneficiary
The most fundamental mistake is not designating a beneficiary at all. Simply naming a spouse or a child may also not be enough. Consider scenarios where you and your spouse pass away simultaneously, or your named beneficiary predeceases you. If no living beneficiaries are on record at the time of your death, the insurance payout will default to your estate, which may cause additional complications.
The Risks of Payouts Going to Your Estate
If the death benefit defaults to your estate, several problems can arise. First, the sum may become subject to probate, delaying the payment to your loved ones. Secondly, if the insurance payout is part of your estate, it may be open to claims from creditors. To avert this, consider naming primary, secondary, and tertiary beneficiaries. This way, if the primary beneficiary isn't available, the secondary and tertiary beneficiaries are next in line.
The Complications of Naming a Minor Beneficiary
Designating a minor as a beneficiary poses its own set of problems. Insurance companies seldom disburse payouts directly to minors. Instead, a court-appointed guardian will manage the funds until the minor comes of age— a process that can be both expensive and lengthy.
To work around this, you may set up a trust for the minor beneficiary. The trust can then manage and distribute the insurance proceeds according to your specified terms. An estate planning attorney can provide tailored advice for your situation.
Understanding Per Stirpes vs. Per Capita
When naming multiple beneficiaries, you might also need to decide how to distribute shares if one beneficiary predeceases you. You can opt for a “per stirpes” arrangement, where the deceased beneficiary's share goes to their heirs, or a “per capita” arrangement, where the share is redistributed among the remaining beneficiaries.
It's essential to make this clear on the beneficiary designation form, even if you don't use the legal jargon.
Potential Disqualification from Government Benefits
Be cautious if your beneficiary is currently receiving or may qualify for government assistance, such as disability benefits. Receiving a life insurance payout could compromise their eligibility. An estate attorney can guide you on how to best structure the beneficiary designation in such cases.
Generally, life insurance payouts are tax-free. However, exceptions exist, particularly when the policy owner, the insured, and the beneficiary are three different individuals. For example, if a mother owns a policy on her husband's life, naming their children as beneficiaries, this could create a taxable gift. A financial or tax advisor can help clarify the most tax-efficient way to structure your policy.
By being mindful of these six common pitfalls, you can make more informed decisions when designating your life insurance beneficiaries, ensuring that your intended financial protection fully serves its purpose.
Krista McBeath is an Investment Advisor, Chartered Financial Consultant, a Licensed Insurance Advisor, a Fiduciary, and an experienced tax advisor who specializes in financial planning, investments, and insurance.
The McBeath Financial Group team utilizes advanced tools for in-depth calculations that analyze tax and retirement scenarios to help their clients avoid a future tax time-bomb. Whether this means enjoying more of your hard-earned money in retirement or passing along assets to loved ones with less tax burden, planning makes the difference.
Krista's Amazon best-selling book, The Generational Wealth System outlines a holistic approach to preserving lifestyle, wealth and legacy.