Life Insurance Beneficiary — Who Should It Be?

by Neal Frankle, CFP ®

Selecting the right life insurance beneficiary isn’t a game of playing favorites. You need to do some smart planning in order to maximize the benefit to your family and thereby minimize the tax bite the government takes. The last thing you want to do is give all the loot to one person and force the other family members to start borrowing money to pay the government. How is that done?

The most important thing you need to do is to determine what your objectives are.

If you own term life insurance, you probably bought it to protect your family in case you die prematurely. That being the case, the money will be invested by your surviving spouse or beneficiary to create income for your family. If this is your situation, what are your choices?

a. Don’t name anyone.

Bad idea. This means the money needs to be probated – a costly and lengthy process. Once you realize what probate is and how much it costs, you’ll understand why you should avoid this at all costs.

b. Name “wife” or “children.”

Also bad idea. What if you have been married more than once before you die? Which wife? Which child? Again…this will end up in court.

c. Name specific people you want to provide for.

YES. This could be a good choice. If you go this route, the person you name will get the money tax-free and without resorting to probate. Sweet. If you are married, your spouse will likely be the best choice but not in all cases. Just remember to always name a contingent beneficiary just in case your spouse predeceases you. Also, remember to update the form whenever there is a change in your status or the status of your beneficiaries.

d. Name your living trust.

This is an option and possibly a good one. The benefits of this choice are that you don’t need to continually update the life insurance beneficiary form. The downsides are that your beneficiary may give up some control over the assets.

Choosing between “c” and “d” is a very complicated question. Since it’s very particular to your own situation, I strongly recommend you speak with a qualified estate planning attorney before you make your decision. This decision is very different from deciding who should be your IRA beneficiaries.

If you own permanent insurance and the goal is estate planning, you probably want to name an irrevocable life insurance trust as the owner of the policy. This way, you’ll leave the money outside your estate and it will all be available to pay estate taxes if there is a need to do so.

A bigger question is, what do you do if you have both an immediate need for family protection and estate tax problems? In other words, you’ll want to have the proceeds available both to replace your income should you die prematurely and to pay the estate tax after you die.

This isn’t so difficult to address, and here’s why. If your assets are really large enough to trigger estate tax, you probably don’t have to worry about creating enough income to replace your pay once you die. After all, the ceiling is currently $5 million.

But if you have a very unique situation whereby your family would be at risk should you die prematurely, and at the same time you fear they’ll face estate taxes eventually, the best answer is to have more than one policy. Get a cheap term insurance policy to provide for your family during the period you need to replace your income. Buy a permanent insurance policy to cover your long-term estate planning needs.

How did you decide who to name as beneficiary of your life insurance? Why?



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{ 2 comments… read them below or add one }

Sonya March 10, 2011 at 1:46 PM

There are so many insurance carriers out there its difficult to choose. It took a lot of trial and error to find one I’m comfotable with. Now I have a great policy and less worries. Great post.


Jackie March 10, 2011 at 7:51 AM

I spoke with my insurance company and an estate planner to understand what my options were, and then decided based on my goals.


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