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10 Common Mistakes in Naming Beneficiaries

Naming a minor child

Life insurance companies won’t pay the proceeds directly to minors. If you haven’t created a trust or made legal arrangements for someone to manage the money, the court will appoint a guardian to handle the proceeds until the child reaches 18 or 21, depending on the state. This is a costly process.

Instead, you can leave the money for the child’s benefit to a reliable adult; set up a trust to benefit the child and name the trust as the beneficiary of the policy; or name an adult custodian for the life insurance proceeds under the Uniform Transfers to Minor Act.

Making a dependent ineligible for government benefits

Naming a lifelong dependent, such as a child with special needs, as beneficiary puts the loved one at risk for losing eligibility for government assistance. Anyone who receives a gift or inheritance of more than $2,000 (in most states) is disqualified for Supplemental Security Income and Medicaid, under federal law.

Work with an attorney to set up a special needs trust, and name the trust as beneficiary. A trustee you appoint will manage the money for the dependent’s benefit.

Overlooking your spouse in a community-property state

Generally you can name anyone with whom you have a relationship as beneficiary, even a secret lover. However, in community-property states, your spouse typically would have to sign a form waiving rights to the money if you designate anyone else as beneficiary. Community-property states are:

New Mexico

 Falling into a tax trap

Life insurance death benefits are generally tax-free — except when three different people play the roles of policy owner, the insured and the beneficiary. In that case, the death benefit could count as a taxable gift to the beneficiary.

For example, a wife owns a life insurance policy on her husband’s life and names their adult daughter as beneficiary. The wife effectively is creating a gift of the policy proceeds to her daughter. The person who makes the gift (the wife) is the one who would be subject to the tax, if the amount of the gift exceeds federal limits.

The problem could be avoided by having the husband own the policy, insuring himself.

Assuming a Will trumps the policy

A life insurance policy is a contract. Regardless of what your will says, the life insurance money will be paid to the beneficiary listed on the policy. That’s why it’s important to contact your insurer to change your beneficiary if needed.

Forgetting to update

You should review your policy every three years and after major life events, such as marriage, having children or divorce. Change the beneficiaries when circumstances change.

Neglecting details

Be specific when you name beneficiaries. Instead of “my children,” list their names, Social Security numbers and addresses.  Otherwise, the insurance company has to launch a search and that can be time consuming. When naming multiple beneficiaries, decide  on the percentage of the proceed.

Staying Silent

Be sure to tell someone that you have a life insurance policy, where it is and how to find it.  We created the “Dear Family” Guidebook as a solution to this and documenting other important information for your family to know. The guidebook is available in an electronic version and also paper. Get your copy by following this link:

Giving money to a young adult

Naming your young-adult children as beneficiaries without setting any conditions for how the money is dispersed can be a setup for financial failure. How many 18- or 21-year-olds can handle a huge influx of cash? One way is  to set up a Trust with specifics for how the money can be released and what it can be used for until the young adult reaches a certain age.

Insurers are beginning to introduce policies that let you arrange for the death benefit to be paid out in installments.

Naming only a primary beneficiary

Many people make their spouse beneficiary, but don’t take into account the spouse might predecease them.  Always list a secondary beneficiary and final beneficiary.  If the primary beneficiary dies before you do, then the money passes to the secondary beneficiary. If the secondary beneficiary has passed away when you die, then the death benefit goes to the final beneficiary.

Sometimes people fail to name any beneficiary. When there is no living beneficiary, the life insurance benefit is payable to the estate and is subject to probate. That leads to two complications. One, heirs might face a long wait to get the money. Two, the life insurance proceeds, which normally would be protected from creditors, can now be open to creditors’ claims.