In estate planning, there are right ways and wrong ways to designate beneficiaries for your life insurance. Here are some common mistakes people make:
Assuming a Will or Trust controls the beneficiary designation.
This point cannot be hammered home often enough. Neither your Will nor your Trust will control or “trump” a beneficiary designation made with the insurance company. If you make a designation on the insurance company form, that is the one that will control what happens to the insurance money. All insurance companies require you to complete a beneficiary designation when you sign up for the policy, so you most likely do have a designation — whether you remember it or not!
The only way your Will is going to decide who gets the policy is if you either have no designation made (again, that is highly unlikely), or the person you designated is already deceased and you did not designate a contingent beneficiary. Only then will the policy pay out to your estate and be governed by the probate of your Will. Your Trust will not decide things unless the policy pays to your estate and your Will leaves it to your Trust, or the Trust is the designated beneficiary with the insurance company.
Failing to name a contingent beneficiary.
A contingent beneficiary, sometimes called a secondary beneficiary, names the person or persons you want to get the policy if your first choice dies before you do. This is like naming a backup. Many people fail to do this. It usually happens because, when they bought the policy, they wanted to “think about it” and the insurance company only required that they name the primary beneficiary.
A lot of folks fail to go back and designate the contingent beneficiary. When the primary beneficiary fails to outlive the insured, who then dies without having named a backup, the policy pays out to the insured’s estate. This usually means that a probate will be required, which can be a very expensive and time consuming process. If you also failed to make a Will, the state will decide who gets your insurance money!
Never updating the beneficiary designation.
Has it been a long time since you bought the policy and setup the initial beneficiary form? If so, it’s probably time to review that designation and see if changes are in order. People you had named may have passed away, children may have grown, circumstances may have changed. Don’t rely upon your memory either — many people are surprised to see who the designated beneficiaries are when they order a copy of the beneficiary form from the insurance company.
Naming a minor child as beneficiary.
This can be a recipe for disaster. The insurance company will not pay out to a minor. A court proceeding will probably be necessary and, depending upon the size of the policy, the court may require that it be held in a special court-supervised account until the minor reaches age 18. At that time, the court will distribute the funds to the young person. At age 18. Is that really what you want?
Naming a person with special needs as a direct beneficiary.
If you have a loved one receiving needs-based government assistance (SSI, Medi-Cal, etc.), then you probably already know how careful you need to be to ensure that you don’t accidentally cause ineligibility.
Naming the recipient as a life insurance beneficiary is a sure way to cause a problem with non-exempt income and countable resources. If nothing is done, the person will probably lose all government benefits until the life insurance money is spent, and then may have to re-qualify for benefits (which may or may not be awarded again!)
To prevent this, a court proceeding will be necessary to setup a special trust to hold the money and use it for permitted purposes during the recipient’s lifetime. This is time consuming and expensive, during which the recipient’s benefits are still threatened. Moreover, anything left when the recipient dies will go to the government, not to other family members.
An estate planning lawyer can help you setup a special trust that can be the direct beneficiary of the policy, use proceeds for the recipient, yet still pass the remainder on to your family when the recipient dies.