Advising your clients on who to name as their life insurance beneficiary sounds simple, but can actually get tricky. Mistakes are common, and they can be heartbreaking and expensive. Email nick
Here are 10 life insurance beneficiary mistakes to help your clients avoid:
1. Naming a minor child
Life insurance companies won’t pay the proceeds directly to minors. If your client hasn’t created a trust or made any legal arrangements for someone to manage the money, the court will appoint a guardian — a costly process — to handle the proceeds until the child reaches 18 or 21, depending on the state. Instead, your client can leave the money for the child’s benefit to a reliable adult; set up a trust to benefit the child and name the trust as the beneficiary of the policy; or name an adult custodian for the life insurance proceeds under the Uniform Transfers to Minor Act.
2. Making a dependent ineligible for government benefits
Naming a lifelong dependent, such as a child with special needs, as beneficiary puts the loved one at risk for losing eligibility for government assistance. Anyone who receives a gift or inheritance of more than $2,000 is disqualified for Supplemental Security Income and Medicaid, under federal law. Work with an attorney to set up a special needs trust, and name the trust as beneficiary. A trustee your client appoints will manage the money for the dependent’s benefit.
3. Overlooking a spouse in a community-property state
Generally your client can name anyone with whom they have a relationship as beneficiary. However, in community-property states, their spouse typically would have to sign a form waiving rights to the money if your client designates anyone else as beneficiary. Community-property states are Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin.
4. Falling into a tax trap
Life insurance death benefits are generally tax-free — except when three different people play the roles of policy owner, the insured and the beneficiary. In that case, the death benefit could count as a taxable gift to the beneficiary. Say, for instance, a wife owns a life insurance policy on her husband’s life and names their adult daughter as beneficiary. The wife effectively is creating a gift of the policy proceeds to her daughter. The person who makes the gift — the wife — is the one who would be subject to the tax, if the amount of the gift exceeds federal limits. The problem could be avoided in most cases by having the husband own the policy, insuring himself.
5. Assuming a will trumps the policy
A life insurance policy is a contract. Regardless of what your client’s will says, the life insurance money will be paid to the beneficiary listed on the policy. That’s why it’s important for your client to contact their insurer to change their beneficiary if needed.
6. Forgetting to update
Designating beneficiaries are not ‘set it and forget it’ events. You should review your client’s policy every three years and inquire about major life events, such as marriage, having children or divorce. Change the beneficiaries when circumstances change.
7. Neglecting details
Urge your clients to be specific when naming beneficiaries. Instead of “my children,” list their names, Social Security numbers and addresses. Otherwise, the insurance company has to launch a search and that can take a lot of time. When naming multiple beneficiaries, have your client decide whether they want the money divided “per stirpes,” which means by branch of the family, or “per capita,” which means by head.
8. Staying mum
Advise your clients to tell their loved ones that they have a life insurance policy, where it is and how to find it. Open communication with beneficiaries now can save a family from chaos later — or even worse, never claiming the benefit.
9. Giving money with no strings attached
Naming young-adult children as beneficiaries without setting any conditions for how the money is dispersed can be a setup for financial failure. How many 18- or 21-year-olds can handle a huge influx of cash? One way is to set up a trust with specifics for how the money can be released and what it can be used for until the young adult reaches a certain age. Insurers are beginning to introduce policies that let your clients arrange for the death benefit to be paid out in installments.
10. Naming only a primary beneficiary
Most people just think they’re going to make their spouse beneficiary, but don’t take into account the spouse might predecease them. When there is no living beneficiary, the life insurance benefit typically goes into the estate and is subject to probate. That leads to two complications. One, heirs might face a long wait to get the money. Two, the life insurance proceeds, which normally would be protected from creditors, can now be open to creditors’ claims. Recommend that your client names secondary and final beneficiaries. If the primary beneficiary dies before they do, then the money passes to the secondary beneficiary. If the secondary beneficiary has passed away when your client dies, then the death benefit goes to the final beneficiary.
