In the language of life insurance, a beneficiary is the recipient of the proceeds of the policy when the named insured dies. The owner of a life insurance policy has a great deal of flexibility in naming beneficiaries and can generally name anyone he or she chooses, but insurable interest has to exist in order for a beneficiary to be named. When making beneficiary decisions, it is important that the wishes of the policyowner are fulfilled and that legal complications are avoided.
Types of Beneficiaries
Beneficiaries are typically categorized as primary and contingent. A primary beneficiary is entitled to the proceeds of the policy upon the death of the insured, but such rights expire if he or she dies before the insured. A contingent (or secondary) beneficiary is entitled to the policy proceeds if the primary beneficiary has predeceased the insured. Most designations are prepared to provide a one sum settlement to the primary beneficiary. Occasionally, an arrangement might stipulate that, if policy proceeds are being paid over time to a primary beneficiary who dies before collecting the entire amount, then the remaining proceeds will be payable to the contingent beneficiary. It is often desirable to have several levels of contingent beneficiaries.
A beneficiary can be either specific (a person identified by name and relationship), or a class designation (a group of individuals such as the “children of the insured”). While the naming of specific beneficiaries is usually clear-cut, unintended complications can arise when designating classes of beneficiaries.
For example, if you plan to name your children as beneficiaries, you will need to clarify if you intend to include only your lawful children, adopted children or children by a former spouse. If your children are minors, it is also important to determine if the insurance company will in fact pay the proceeds to a minor beneficiary. Generally, insurers insist on paying proceeds to a legal guardian rather than to a minor. You may want to designate a custodian under the Uniform Transfers to Minors Act to act on behalf of the minor as this would eliminate the need to appoint a legal guardian.
Consider the following hypothetical situation in which the policyowner’s intentions appear straightforward, but which could become complicated. Harriet, who is 70 years old, has planned for the proceeds of her life insurance policy to be paid to her children (Sam, Carol, and Jill) or her grandchildren. Now, suppose Sam and Carol die before their mother. Sam leaves four children and Carol has no children. How will the proceeds of the policy be distributed when Harriet eventually dies?
Methods of Distribution
Per stirpes and per capita are terms that describe methods of distributing property to family members and heirs. Per stirpes means “branches of the family,” and per capita means “by heads.” In the example above, under a per stirpes distribution, Jill (one branch) would receive one-half of the proceeds and Sam’s surviving children (the other branch) would divide the remaining half among themselves. Under a per capita distribution, Sam’s four children, along with Jill, would each receive one-fifth of the proceeds. Remember, there might be complications if any of Sam’s children are still minors when Harriet dies and legal guardians have not been appointed.
Revocable vs. Irrevocable
There are also different consequences according to whether beneficiary designations are revocable or irrevocable.
If a beneficiary designation is revocable, the policyowner reserves the right to change the beneficiary. A person designated as a revocable beneficiary has only an “expectation” of benefits, since the owner of the policy can exercise any of the policy rights without the consent of the revocable beneficiary.
An irrevocable beneficiary, however, cannot be changed without the consent of that beneficiary. While this arrangement is sometimes desirable for estate planning purposes, the legal status of an irrevocable beneficiary is uncertain. Some may regard an irrevocable beneficiary as a “co-owner” of the policy; therefore, the beneficiary’s consent is needed to exercise any policy rights. On the other hand, others may contend that an irrevocable beneficiary’s consent is needed only for exercising a change of beneficiary.
The latter position can create the somewhat puzzling situation of compromising the beneficiary’s rights if the policyowner exercises other rights, such as surrendering the policy or permitting it to lapse. Due to the vague legal status of an irrevocable designation, it is usually preferable to use revocable beneficiary designations.
The distribution desired by a policyowner must be clearly set forth in the beneficiary designation. A change in family circumstances after a policy is initially written, such as a divorce, could leave you with unintended beneficiaries. If you are unsure about how your beneficiary designation has been recorded, check your policies, and take the steps necessary to make the appropriate changes.