When applying for life insurance, one of the decisions you'll be asked to make is who you want to designate as the beneficiary or beneficiaries of your policy. As the policy owner, it's important that you understand all of your available options.
An insurable interest
A life insurance beneficiary is a person or entity that will receive the proceeds of your life insurance policy when you die. As the policy owner, you can generally name anyone you want, however, an insurable interest must exist in order for a beneficiary to be named.
For the purpose of life insurance, an insurable interest is a relationship in which one party will suffer financial loss in the event of the death of the other. For a life insurance policy to be issued, there must be an insurable interest between the insured and the beneficiary. Insurable interest protects against someone who has no interest in your life profiting from your death.
Beneficiary OptionsBefore selecting a beneficiary, you need to understand who or what is allowed to be named. Some of the most common beneficiary types include:
An individual (or individuals)
You can name one or more individuals as your life insurance policy beneficiary. Most commonly, this is a spouse, a child (or children), or other loved ones who may suffer a financial loss upon your death. Often the life insurance proceeds are used for future living expenses, paying off a mortgage, and to cover final expenses such as funeral/burial costs. The proceeds from your life insurance policy is meant to help these individuals avoid undue financial hardship.
CharityIt's not uncommon for people to continue to support a nonprofit or charity through life insurance proceeds. This is often accomplished by designating a charitable organization or nonprofit as the beneficiary of your life insurance policy. The death benefit is typically passed onto the charity tax free.
Usually, beneficiaries are relatives or very close friends. However, depending on your circumstances, you may prefer to name your trust as your beneficiary. There are many different types of trusts you can establish. For example, if you have a special needs child or other loved one with a life-long disability, you can name the trust as the beneficiary of your life insurance policy. This designates the trustee (the person you choose to manage trust funds) to use the proceeds specifically for the care of your beneficiary. Also, and depending on the type of trust that is established, the life insurance policy proceeds can be excluded from your estate and go directly to the trust. This means that the amount of the death benefit will not be used in the overall value calculation of the estate.*
Finally, it's critical to keep your life insurance beneficiaries updated whenever there's a big life event such as when you get married, experience a divorce, or when a new child or grandchild joins the family.
*Consult with an attorney or tax professional when deciding what type of trust is best for you.