It’s a pretty morbid thought – someone is going to financially benefit from your death.
But should it really creep you out?
Life Insurance Beneficiaries
The purpose of life insurance is to provide much-needed money that you’re no longer able to provide yourself.
It says “I will honor my financial commitments, even after I’m dead.”
Seen in that light, it makes sense to really take your time deciding who will be the beneficiary.
Primary Beneficiary
The primary beneficiary is the person/entity or persons/entities whom you have chosen to receive the death benefit once the insured has passed.
When you die, these are the people who will be paid the entire death benefit by the insurance company. If you name multiple people as primary beneficiaries, you will also have to choose how you want the death benefit divided up between them.
Per Stirpes Distribution
The first way to divide up the death benefit is to elect a “per stirpes” distribution.
Under this distribution scheme, the death benefit is divided up “by representation.” In other words, the benefits are distributed according to whoever is closest to you, relationally.
If one of your primary beneficiaries predeceases you (dies before you), then the funds go to that primary beneficiary’s heirs.
So, for example, let’s say you have two children, John and Matt. Matt has two children, Ben and Britney. If you die, and both beneficiaries are still alive when you die, then your death benefit will be divided equally between both John and Matt. Ben and Britney will receive nothing.
If Matt predeceases you, then his children will receive his share of the proceeds, divided equally. In other words, Ben will receive 25 percent of the proceeds, Britney will receive 25 percent of the proceeds, and John will receive 50 percent of the proceeds.
Per Capita Distribution
This type of distribution simply divides the proceeds equally among the beneficiaries.
If other beneficiaries have pre-deceased another, the beneficiaries who are still living then split the remainder, too.
So, continuing the previous example, if Matt predeceases you, his children receive nothing, and John receives 100 percent of the death benefit proceeds.
There is no blanket “right” or “wrong” way to distribute a death benefit that applies to everyone. You need to think through this carefully because death claims are nearly impossible to challenge in court.
The right decision for your specific situation will be driven entirely by your financial goals, personal wishes, and your personal relationship with each beneficiary.
In most cases, your spouse should be your primary beneficiary, but there are also cases when it’s appropriate to designate children and spouses together – especially when a large estate or a family business is involved.
Contingent Beneficiaries
Contingent beneficiaries, also referred to as “secondary beneficiaries,” are those who are “next in line” after the primary.
These are the beneficiaries that receive death benefit proceeds when the primary beneficiaries are deceased at the time of your death.
It’s important to name contingent beneficiaries because, while unlikely, it’s entirely possible that all of your primary beneficiaries could predecease you, even if you set up distributions under a per stirpes arrangement.
What About Minors?
Minors are a complicated case. Believe it or not, many people aren’t prepared to leave their child money when they die.
If you have children who are underage, one of the worst things you can do is name the child as the beneficiary on your policy without setting up a trust and a financial guardian.
A life insurance company will not pay a death claim to a person under age 18. Instead, it will hold the money, and pay interest on it until the child reaches the age of majority. An insurer may also pay the money to a court-appointed guardian.
Trusts
A trust is a legal arrangement that gives ownership of assets to one person for the benefit of another.
In this case, you would set up a trust arrangement for your child and appoint a trustee to manage the death benefit proceeds. The trustee is legally prohibited from benefiting personally from the trust assets. The trustee must also manage trust assets responsibly, and is generally bound to something called “the prudent man rule.”
This principle states that the trustee must manage the funds in the trust in the same way a prudent man would – focusing attention on the preservation of assets rather than appreciation of them.
Trust arrangements can also specify how funds are to be distributed even after the child reaches age 18.
In many cases, you can control the death benefit proceeds from beyond the grave, distributing them over a set period of time or over the child’s entire lifetime using an annuity.
