Life insurance beneficiaries are frequently spouses and children of the insured. However, we live in a dynamic world in which the “typical” family may not be so typical. Consider these statistics about U.S. families:

In 2010, there were 2,096,000 marriages in the U.S.

In 2005, a report by the State of Our Unions said that 8.1% of all coupled households were unmarried heterosexuals.

The same 2005 report also showed that only 63% of all children in the U.S. live with their biological parents. This is the lowest in the Western world.

The person or people you name as a beneficiary is a choice only you can make, but it’s a vitally important choice.

Primary and Contingent Life Insurance Beneficiaries

How do you designate a life insurance beneficiary legally? There are two basic types of life insurance beneficiaries:

Primary beneficiary: The primary beneficiary is the person (or persons) who will receive the proceeds of the life insurance policy when the insured person dies. However, the primary beneficiary will not receive any proceeds if he or she dies before the death of the named insured.

Contingent beneficiary: This is also known as the secondary beneficiary. The contingent beneficiary will not receive any of the life insurance proceeds if the primary beneficiary is still alive when the insured person dies. The contingent beneficiary is only entitled to receive proceeds if the primary beneficiary dies before the named insured.

Many professionals in the industry feel that the best or safest approach is to name a primary beneficiary and a contingent beneficiary on a life insurance policy.

There are two classes of beneficiaries known as revocable and irrevocable beneficiaries.

Revocable beneficiaries: The owner of the life insurance policy has the right to change the beneficiary designation at any time without the consent of the previously named beneficiary.

Irrevocable beneficiaries: The owner of the life insurance policy cannot change the designation of the beneficiary without the consent of the original beneficiary.

Which is the better choice? Most experts consider that the simplest way is to go with a revocable beneficiary option. There are a number of potentially complicated legal issues that can occur if you opt to go with an irrevocable beneficiary.

How do you choose who should be your life insurance beneficiary? You should consider:

Family: One or more immediate family members who are dependent on you for both your income and financial support should top your list of potential beneficiaries. Your primary and contingent family beneficiaries can include your spouse or domestic partner, children, brothers and sisters, parents, or any other member of your family. It is up to you decide on the order of importance.

Legal guardian: If your named beneficiaries are minors (under the age of legal consent), the life insurance company may require that you name a legal guardian as the beneficiary. Alternatively, you can designate a legal guardian using the Uniform Transfers of Minors Act on their behalf instead of using a legal guardian. Note that even if you have named a guardian as beneficiary, the proceeds will not be paid until the court has specifically appointed a guardian or approved the named beneficiary as guardian for the minor(s).

Estate: You can choose your estate as beneficiary. The proceeds will go to the Executor or Administrator of the estate. This is the person or entity designated in the insured’s last will and testament, and who must be approved or designated by the probate court. However, you can only use your estate as the named beneficiary if you have drawn up a last will and testament, and must not name a specific person on the beneficiary designation of your policy. Be sure to discuss the tax implications of naming your estate as beneficiary with your accountant, financial advisor or insurance agent.

Trusts: A trust must be set up before you can designate one or more trustee and name the trust beneficiaries.

Charity: You can name a charity as either the primary or contingent beneficiary.

Key person life insurance: It is a common practice for a business to purchase life insurance on key personnel in the company. This form of life insurance may be owned by the company, in which case the business is typically the beneficiary of any applicable life insurance beneficiary policies. Or the business owner may buy a life insurance policy and name a co-owner as beneficiary, enabling the co-owner to purchase the policyholder’s share of the business if the policyholder dies.

If you want to name more than one life insurance beneficiary, there are two approaches you can take:

Per stirpes: You can designate your beneficiaries by “branches of the family or lineage.” This means that the life insurance proceeds would be passed down to be divided equally among the beneficiaries and/or the surviving children of the beneficiaries.

Example: You, as the insured, designated your son (John) and daughter (Jane) as beneficiaries. Your son John dies before you do. If you were to pass away next, then Jane would receive 50 percent of the proceeds and the remaining 50 percent would then be apportioned equally to all of John’s surviving children.

Per capita: Simply put, the proceeds are divided equally among all the beneficiary survivors of the lineage line.

Example: Using the above scenario, suppose John had four children and Jane had no children when you, as the insured, passed away. This means that the proceeds would be divided equally between John’s four children and Jane. Since there are a total of five beneficiary survivors, each beneficiary would get one-fifth of the life insurance proceeds.

If you have multiple beneficiaries, it is best to designate that proceeds will be distributed as a percentage rather than a dollar amount.

Why? You might buy a $100,000 universal life insurance policy and apportion $50,000 to your two children as beneficiaries. But, when you pass away, the policy could be worth $120,000, and the insurance company will have no instructions on how to legally divide up the remaining $20,000. An unfortunate and avoidable legal battle could ensue for the remaining portion of your policy.

If your beneficiary dies before you do, you must rename the beneficiary on the policy as soon as possible. How do you do this? All you have to do is contact the life insurance company and request a “change of beneficiary” form.

If both the insured and beneficiary die at the same time, then the proceeds would go to the insured’s estate.

Here are some things you should do and some things you must avoid when naming a beneficiary:

DO identify the primary beneficiary. This should include their full name(s), date of birth, and/or social security numbers.

DO designate percentages rather than specific dollar amounts.

DO include a secondary or contingent beneficiary in your policy.

DO re-visit your life insurance policies every few years to ensure the beneficiary designations are current.

DO amend your life insurance policy if your circumstances change, for example in the event of a new addition to the family, the death of a beneficiary or divorce.

DON’T name a beneficiary generically such as “wife,” or “spouse” or “children.” If you file for divorce and do not specifically name a designated beneficiary(s), there will likely be a legal battle for the benefits of your policy. Likewise, in the event that a family member becomes disenfranchised for any reason, you will want to ensure that your beneficiaries are specifically named.

DON’T forget to include anyone such as adopted children or grandchildren if you have named heirs as beneficiaries, contingent beneficiaries, etc.

DON’T use “estate” as beneficiary when you have specific family members that you want to receive the proceeds from. If you name your estate as beneficiary, the proceeds will become entangled in the estate probate and could cause potential tax issues. Your creditors will also be able to place their claims against the estate proceeds. Named beneficiaries get the proceeds of a life insurance death benefit directly.

DON’T name minors unless you have a designated guardian for the children.

DON’T have a separate owner, named insured, and beneficiary on a policy; it could result in tax problems. Example: You buy a policy for your son John and your policy names his spouse Julie as the beneficiary. If John dies, it is very possible that the IRS may view the proceeds as a gift from you (the owner of the policy) to Julie (the beneficiary) and they could tax the proceeds. 

DON’T name a creditor as a beneficiary.

Naming a beneficiary requires some thought. If you don’t put some thought into how you name your beneficiaries, your family and estate may face legal or tax complications. Always keep your beneficiary information current on all your life insurance policies.