If you're thinking about getting life insurance, it’s probably because you have a person or people you want to protect financially when you’re no longer around to provide for them. These are the people you would likely designate as a beneficiary or as beneficiaries on your policy.
A life insurance beneficiary is who you are saying you want the life insurance policy's death benefit to go to after you pass away. The beneficiary can be one person, such as your spouse, or there can be multiple beneficiaries. But you can also designate a trust or charity as your beneficiary.
The beneficiaries of your life insurance policy don’t have to receive equal shares of the death benefit; you can divide the payout any way you prefer. You can also choose contingent beneficiaries who will get the death benefit if your primary beneficiaries are deceased or can’t be found.
How do I choose a life insurance beneficiary?
Your life insurance beneficiaries would be anyone who depends on you financially and would need financial help if you died. Often, it’s a spouse or other family members. Financial dependence isn’t limited to just relying on your income, either. For instance, if you’re a stay-at-home parent and your family would need to pay for childcare in the event of your death, that’s an expense that a death benefit could help pay for.
You can also designate a trust that is set up to financially support your loved ones as the beneficiary, or a charitable organization as a beneficiary if you want the death benefit to go toward one of your favorite causes.
Life insurance beneficiary rules
There are few rules restricting your choice of a life insurance beneficiary on a policy that you purchase for yourself. But if you name a minor as a beneficiary, a court will need to be involved. A minor can't receive funds from a life insurance policy directly, so the death benefit would have to go to the minor’s legal guardian (and the court would have to name one if a guardian has not been designated). It’s a process that can get contentious and complicated quickly, so it’s better not to name a minor as a beneficiary.
Many people bypass court involvement by setting up a trust as the beneficiary, and the trustee administers the money on behalf of the minor according to your wishes.
You can also designate a trusted adult as your beneficiary and include instructions in a will on how to use the proceeds to take care of the child. However, this can create complications, as the trusted adult does not have a fiduciary duty to the minor, and creditors of the adult can access the death benefit. Setting up a trust is likely a better option.
If your primary beneficiary has died and you have no secondary beneficiaries, the death benefit would go to your estate and your estate would be subject to probate, even if you have a will. This means it could be contested and creditors may try to make a claim for any debts you owe before the money is distributed to your heirs. But your beneficiary designations trump what’s stated in a will — which is why it's a good idea to review your policy's beneficiaries every year and make sure they reflect your wishes.
For life insurance policies where the policyholder is not the insured person, beneficiaries need to have an “insurable interest” in the insured person. Having an insurable interest means you would suffer financially as a result of the insured person's death. For example, you can purchase a life insurance policy for your spouse with yourself as the beneficiary, but you can't name yourself beneficiary on a policy you buy on an acquaintance who doesn't affect your finances.
Are the rules different when your spouse is your life insurance beneficiary?
Normally, the beneficiary you name on your policy remains in place unless you change the policy. In some states, however, a divorce will automatically remove your ex-spouse as the beneficiary on your policy unless there is a written agreement to keep your ex-spouse as beneficiary.
If you get divorced after you have set up your beneficiaries, you should be sure to name a new beneficiary so that the death benefit is paid to someone you have chosen. Again, because your beneficiary designation trumps what you put into a will, it’s always important to keep your beneficiaries up to date.
Do beneficiaries pay taxes on life insurance policy benefits?
Generally, beneficiaries do not owe income taxes on a life insurance payout, and they would not have to report the money on their income tax returns. However, a death benefit could be subject to estate tax depending on whether your life insurance is included in your estate and your estate exceeds the estate tax exemption set by federal or state law.
Who can change the beneficiary on a life insurance policy?
In most cases, only the policyholder can change the beneficiary, but there are exceptions:
Power of attorney: Depending on state law, a power of attorney for you can change the beneficiary on your life insurance policy. As such, a power of attorney should be someone you trust.
Community property laws: If you live in a community property state, your spouse is usually considered to be a partial owner of your life insurance policy, since the money used to pay the premiums is considered the property of both of you. A community property spouse may have rights to the death benefit.
Irrevocable beneficiary: Some life insurance policies are written with an irrevocable beneficiary, which means you can't remove that beneficiary from the policy without their consent.
Will my life insurance beneficiary have enough from my policy?
In order to determine whether your life insurance beneficiary would have enough, you need to figure out all the expenses you’re trying to cover with your death benefit, and for how long. A financial advisor can help you calculate your needs and tailor a plan for life insurance to ensure you have enough financial protection for your family.