Who Should Your Client Name as a Beneficiary?
Americans pay hundreds of billions of dollars in life insurance premiums per year. Most
policyholders will never see a payout themselves. Instead, it will go to their loved ones to
provide for them when the policyholder dies.
Life insurance benefits and claims totaled $797.7 billion in 2022, including more than $88 billion
in death benefits, according to the Insurance Information Institute.1 The typical life insurance
payout is approximately $168,000.2
If a policyholder designates a beneficiary on their life insurance policy, the death benefits are
not typically part of a decedent's estate that goes through the probate process because they
pass directly to beneficiaries. However, the potentially large cash value it can provide makes it
central to estate planning and requires careful consideration about how to structure the
beneficiary designation.
Naming a Spouse or Children as Beneficiaries
The most common beneficiaries of a life insurance death benefit are a surviving spouse and/or
children.
Life insurance death benefits are typically protected from creditor claims for policyholders' debts.
But once the designated beneficiary receives the death benefits, the beneficiary's creditors can
go after the funds to satisfy the beneficiary's debts - even debts owed jointly with the deceased
policyholder (for example, an outstanding loan or credit card debt where the policyholder and
the spouse are co-signers). This is true whether the beneficiary is the policyholder's spouse,
child, or other loved one.
The death benefit of the life insurance policy may also be open to claims of the named
beneficiary's spouse. If a surviving spouse beneficiary remarries or a child beneficiary divorces,
for example, the death benefit proceeds received by the beneficiary and put into one of their
accounts or investments could end up being categorized as marital assets and, therefore,
subject to equal division in the event of a divorce. This outcome could countermand the
intention of the policyholder.
If no beneficiaries are named on an insurance policy or if the beneficiary named is the
policyholder's estate, then a probate estate will likely need to be opened to administer and
transfer the death benefit to the policyholder's heirs or beneficiaries. Once the probate estate
has been opened, the deceased policyholder's creditors may have an opportunity to claim the
death benefit before the funds are distributed to the heirs or beneficiaries of the estate.
Minor child beneficiaries present challenges as well. Insurance companies cannot pay
insurance proceeds directly to minor children. An adult will usually have to be appointed to
manage the funds until the child reaches the age of majority. Depending on your state, this may
involve a court proceeding and annual reporting requirements that cost money and can delay
the payout.
Some life insurance policies allow a custodian to be assigned to a minor child beneficiary
without needing a probate court appointment. A custodian manages the money for the minor
child until they reach legal adulthood, when the assets are turned over to them.
Naming a Charity as Beneficiary
A life insurance policy can be a way to make a charitable gift at the end of life. This option might
appeal to a client who purchased a policy to protect a spouse or children who no longer need it,
to complete payment of a mortgage, tax, or other debt that is no longer a concern, or to cover
some other contingency that no longer requires the funds a life insurance policy would have
provided.
A life insurance policy can also be purchased for the express purpose of charitable giving. In
addition to taking out a new policy to benefit charity, a charitable recipient can be named as a
beneficiary on an existing policy to receive all or part of the policy proceeds. Other options
include transferring ownership of a policy to a charity and gifting dividends from a life insurance
policy to a charity.
Each of these options can provide tax benefits. Depending on how a life insurance gift is made,
the cash value of the policy, the cost of premiums paid, or the value of dividends may be
deducted.
Creating a Trust for a Loved One
Naming individuals as life insurance beneficiaries can provide convenience and flexibility for
beneficiaries because the money passes to them quickly and easily outside of probate. The
beneficiaries only need to file a claim with the life insurance company and select how they want
the death benefit to be paid (usually in periodic payments or a lump sum).
However, there are downsides to setting up a death benefit in this way. The policyholder
ultimately loses control over how the insurance proceeds are used. They may have intended to
protect their loved ones financially - but if they are deceased and the funds are in the hands of
their beneficiaries with no controls or restrictions, can they ensure that the benefit is used in
accordance with their wishes?
They can. Policyholders can control the death benefits of their life insurance policy by naming a
trust they have set up as the policy's beneficiary and allowing a trustee to manage the death
benefit on behalf of trust beneficiaries, such as a spouse or children. This arrangement allows
the client to provide instructions about how the money should be used and managed.
A trust can be useful for leaving money to underage or special needs children. It can also
ensure that a disabled beneficiary remains eligible for government assistance or keep a young
adult from spending the funds all at once. Insurance proceeds held in trust are also protected
from creditors and exempt from probate.
Advising Clients on Life Insurance
About 90 million American families rely on life insurance for financial protection and retirement
security.3 However, recent survey data indicates that more than 100 million Americans are
facing a life insurance coverage gap, presenting an opportunity for advisors to steer them
toward these products.4
As a value add, advisors can explain how life insurance fits into an estate plan and walk them
through the different options for naming beneficiaries. These discussions could open new
revenue streams, such as establishing trusts and charitable donations.
Please contact our team for a primer on life insurance and estate planning and how our
practices can benefit each other.
MEREDITH | PC
4325 Windsor Centre Trail
Suite 400
Flower Mound Texas 75028
214-513-1013
This newsletter is for informational purposes only and is not intended to be construed as written advice about a Federal tax matter. Readers should consult with their own professional advisors to evaluate or pursue tax, accounting, financial, or legal planning strategies.
You have received this newsletter because I believe you will find its content valuable. Please feel free to Contact Me if you have any questions about this or any matters relating to estate planning.
