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5 Common Mistakes When Naming Life Insurance Beneficiaries

October 5th, 2017

Naming who will get the insurance proceeds after you die sounds simple, but mistakes are surprisingly common. Failing to properly name beneficiaries could lead to life insurance money being paid to non-intended beneficiaries or results in a costly legal battle for your family.

One thing you don’t want to do is create a problem for your loved ones, that’s why it is important to update your life insurance policy regularly as your family and their needs changes. With that said, here are top 5 mistakes to avoid when designating life insurance beneficiary:

  1. Naming a minor child

Insurers won’t pay proceeds directly to minors. If you haven’t created a trust or designate a guardian to manage the proceeds, the court will appoint a guardian to manage the money for your child (which can be very costly) until the child turns 18 or 21, depending on the state.

Instead of naming a minor as your beneficiary, you can leave the money to a reliable adult or create a trust to manage the proceeds on behalf of your child.

Under Uniform Transfers to Minor Act, an adult can set up a custodial account for a minor.  Consult your attorney before choosing a course of action.

  1. Making a special needs child ineligible for government benefits

Naming a special needs child as a beneficiary may put the child at risk of losing eligibility for government support. Under the federal law, anyone who receives gifts or inheritance above $2000 is disqualified for Medicaid and Supplemental Security Income.

Instead, set up a special needs trust with the help of an attorney and name the trust as the beneficiary. The trust will manage the proceeds on behalf of your child.

  1. Forgetting To Update Beneficiary Information

Failing to update your life insurance policy can leave your loved ones burdened with an unexpected legal battle.

Naming a beneficiary is not a one-time thing because life is constantly changing. You should review and update your policy every two to three years and upon important life events such as divorce, death, birth, and changes in assets.

  1. Failure To List Contingent beneficiaries

If your spouse is your beneficiary and both of you died at the same time and you haven’t named your children as the contingent beneficiaries, your estates will go into probate.

One of the advantages of naming a contingent beneficiary is that if the primary heir doesn’t want the proceeds for some reason (maybe because of tax) and waive the right to the money, the proceeds will go to the contingent beneficiary.

  1. Assuming A Trust Controls The Insurance Policy Designation

If you want the life insurance proceeds to go to a trust you must name that trust as the beneficiary because insurance policy designation controls where the money goes and not the trust. Regardless of whom you designate as your beneficiary, the proceeds are income tax-free.

Life insurance beneficiary designation is very important; failure to properly name your beneficiary can put your loved ones into unnecessary legal battle.

Additional Points to Keep in Mind

Lack of specifics

Simply listing “my children” on your insurance policy can be a problem, especially in a large family. Many states don’t recognize stepchildren when children are listed as beneficiaries. You must be specific.  If you’re not specific unexpected problems may arise, for example, some relatives you lost contact with could suddenly turn up and try to claim the assets.

What happens if one of your children predeceases you?  Unless you are specific, the child’s proceeds will go to your other beneficiaries instead of that child’s children.  The one thing you don’t want to do is disinherit some of your children or grandchildren.

Using shortcuts

If you have 4 children and you want all of them to share the proceeds. You need to name all four of them as your beneficiaries.

If you name one child as your beneficiary and believe that the child will then give others their share, that’s a big mistake. Even if the child is so inclined (legally, he or she is not), the IRS might interfere and levy taxes on the amounts redistributed. Your intent might be pure but shortcuts are never a good idea.