When purchasing life insurance, one of the most essential steps is determining who will be entitled to the death benefits. Before making this decision, it is helpful to understand how life insurance beneficiary rules work.
What is a life insurance beneficiary?
A life insurance beneficiary can be any person or entity you want to receive the death benefits of your life insurance policy after you’ve passed away. For most people, this may be one or more people – typically spouses, children, parents, or even friends. However, a beneficiary can also be a legal entity – such as a trust, charity, or the deceased’s estate.
How does naming a beneficiary work?
Naming your beneficiaries is a very personal decision. Under normal circumstances, most people purchase life insurance because they want it to serve as income replacement when they’re no longer around to provide for those who depend on them. For this reason, many people choose to name their spouse or other family members as beneficiaries.
When listing your beneficiaries, you’re also able to designate them as either primary or secondary beneficiaries. The difference is as follows:
- Primary beneficiaries are first in line to receive your death benefit.
- Secondary beneficiaries (sometimes also called contingent beneficiaries) receive your death benefit if the primary beneficiary passes away before the benefit is distributed.
For example, suppose a husband has named his wife as the primary beneficiary and his two adult children as the secondary beneficiaries. If the husband and wife were unfortunately involved in a fatal car accident, the insurance company would pay the benefits to the secondary beneficiaries – in this case, the two adult children.
It’s important to note that you can change your beneficiaries at any time and it’s good practice to regularly review your named beneficiaries on all life insurance and financial accounts at least once per year. While people often do this in response to significant life events like weddings, divorce, or newborn babies, we recommend that you review your beneficiaries annually.
What happens after the policyholder passes away?
When the policyholder passes away, one of the beneficiaries needs to file a death claim with the insurance company. Death claims require beneficiaries to fill out an application and attach a copy of the death certificate.
The insurance company has up to 30 days to review the application and decide if they will pay the proceeds. If the insurance company denies your claim, you can request a written explanation and appeal the decision.
FAQs About Life Insurance Beneficiary Rules
Below are a few more commonly asked questions regarding life insurance and beneficiaries.
Who is legally entitled to my life insurance?
Only the people or entities you have listed as your beneficiaries are legally entitled to your life insurance death benefits. If you remove them from this list, then they will not receive any of the proceeds.
Does the beneficiary get all the life insurance money?
This depends on the type of life insurance policy.
Whole life insurance policies have a death benefit and cash value. When the policyholder dies, the beneficiaries receive the death benefit, and the life insurance company retains the cash value. If the policyholder borrowed against the cash value and never repaid the loan, the remaining balance will be deducted from the death benefit payout.
Term life insurance policies do not have a cash value component, so the full death benefit is paid out to the beneficiaries.
Do life insurance companies contact beneficiaries?
Since there’s no way for a life insurance company to know that a policyholder has passed away, they will not contact the beneficiaries after the policyholder has died. Typically, one of the beneficiaries will notify the life insurance company and file a death claim.
For this reason, it’s a good idea to let your beneficiaries know that you’ve named them on your policy. That way, they can follow up and collect the death benefit after you have passed.
It’s also important to know that there is no time restriction to claiming the death benefits. If you (or your beneficiaries) learn that you’re a beneficiary of a life insurance policy but the policyholder passed away some time ago, you’re still entitled to the policy’s death benefit.
Do beneficiaries pay taxes on life insurance?
No, beneficiaries are not required to report the death benefits paid out from a life insurance policy on their federal income tax return. However, life insurance proceeds can be counted as part of the policyholder’s estate, potentially triggering estate taxes if its total value exceeds federal and state exemptions.
What rights does the beneficiary of a life insurance policy have?
Beneficiaries are entitled to the death benefit of any policy where they are named the primary or secondary beneficiary. Once the beneficiary receives the payout, they can do whatever they wish with the money unless the policyholder has set stipulations.
On the other hand, beneficiaries also have the right to reject the proceeds. If this happens, the insurance company will pay the benefit to the contingent beneficiary.
What happens if there are no beneficiaries listed?
When the policyholder neglects to list a beneficiary, the death benefit automatically goes to the deceased’s estate. From there, the court (i.e. probate) decides who should receive the funds.
If you have any further questions on life insurance beneficiary rules and or life insurance in general, please reach out to a Principled Life broker. We are eager to help you on your life insurance journey in any way we are able.
