A beneficiary is a person or entity you name in a trust, will or life insurance policy to receive the death benefit. A beneficiary can be:
- One person
- Two or more people
- The trustee of a trust you’ve set up
- A charity
- Your estate
How a Beneficiary Works
The process starts when you open a financial account that will exist after your death, you will usually be asked to designate a beneficiary. This designation is included as part of the paperwork for that account.
A beneficiary designation usually supersedes the instructions in a will, so the will only applies to assets that do not have a named beneficiary. Beneficiary designations should be reviewed regularly, especially after significant life events such as:
- Birth of a Child
- Significant pay increase
- Death of a spouse, partner, or a beneficiary you have already designated
Any major event in your life or that of your beneficiary can create changes that impact you or your beneficiary. Personal relationships change, affecting who you place as a beneficiary to your accounts. Changes to beneficiaries should be expedient after significant life changes if something happens and you have not updated your beneficiary.
There are two basic types of beneficiaries: primary and contingent.
Primary beneficiaries are the account owner’s first choice for a beneficiary. In death, the benefits go to the primary beneficiary still living.
Contingent Beneficiaries are used as a backup if there are no primary living beneficiaries or cannot be found.
For example, an account owner picks her adult child as the primary beneficiary. The adult child would receive all the assets at the time of her mother’s death. However, if the child and mother die simultaneously in an auto accident, there is no primary living beneficiary. As a result, assets will go to a contingent beneficiary, if any exists.
If there is no contingent beneficiary, or when none of the contingent beneficiaries claim the assets, then either state law or the organization’s policies holding the account will dictate what happens to the assets.
Revocable vs. Irrevocable Beneficiary
There are two main categories of beneficiaries, irrevocable and revocable. An irrevocable beneficiary is someone who has full rights to the funds from your financial account or life insurance policy. Even if you want to change the beneficiary on your policy, an irrevocable beneficiary will still receive the death benefit because of the contract terms.
The only way to remove an irrevocable beneficiary from your account is for them to agree to forfeit their rights to the money or account. This can be a difficult situation, especially because removing an irrevocable beneficiary from your policy often involves lawyers. It is not as simple as contacting your insurance company to add a new beneficiary to your policy statement.
When comparing a revocable beneficiary to an irrevocable beneficiary, you can think of them as opposites. A revocable beneficiary is someone who does not have full access to the funds from your life insurance policy. You can remove them from your policy at any time, for any reason, and they do not need to approve this change. They also have no access to your policy and cannot make any changes.
How to Choose Your Beneficiary
When choosing a beneficiary, you need to think about the people who depend on you financially. You’ll likely choose your spouse as the primary beneficiary if you’re married, and your spouse would choose you. Then you would also name beneficiaries if anything happens to you and your spouse.
When deciding who to choose as a beneficiary, it is important to consider people who depend on you for financial support. This could include elderly parents who may need help with medical bills, adult children with college debt, or a family member you have named as the person who will take responsibility for your children if you and your spouse should both pass away.
Since you can name more than one beneficiary, you can specify what (and how much) each of these people would receive when you die. This way, those who depend on you can still count on your financial support.
What if Your Beneficiaries Are Minor Children?
If a minor is named the beneficiary and receives property or money, the minor will not have the authority to take control of that property or those finances until they reach the age of 18 or 21 (depending on the laws of the minor’s state). Children cannot legally enter any contract or receive property until they are adults. The exact details for what happens to the inheritance will vary based on the state’s laws the child lives in and the amount of the inheritance.
Social Security Beneficiary
Social Security benefits help provide beneficiaries an income for retirement or after they become disabled and can no longer work. A Social Security beneficiary receives Social Security or Supplementary Security Income (SSI) Social Security or Supplementary Security Income payments. When a beneficiary passes away, specific steps must be taken to cancel benefits or transfer the payments to an eligible survivor.
- Report the death of the beneficiary to the social security office
- Review if you or any minor children of the beneficiary are entitled to survivors benefits
Social Security survivor benefits are payments made to eligible survivors of a deceased beneficiary. Eligible beneficiaries of survivors benefits include:
- Widows and widowers age 60 or older
- Widows and widowers of any age who are caring for the deceased’s child who is under age 16 or disabled
- Surviving divorced spouses (under certain circumstances)
- Stepchildren, grandchildren, step-grandchildren, and adopted children
- Unmarried children of the deceased who are under 18, or are 18 or over and disabled
- Parents aged 62 or older who were depending on the deceased for at least half their support
Retirement Plan Beneficiary
Selecting beneficiaries for retirement benefits is different from choosing beneficiaries for other assets such as life insurance. With retirement benefits, you need to be aware of the impact of income tax and estate tax laws to select the proper beneficiaries. Although taxes shouldn’t be the sole determining factor in naming your beneficiaries, ignoring the impact of taxes could lead you to make an incorrect choice.
Beneficiaries pay ordinary income tax on distributions from traditional 401(k) plans and traditional IRAs. However, with Roth IRAs and Roth 401(k)s, your beneficiaries can receive the benefits free from income tax if all of the tax requirements are met. That means you need to consider the impact of income taxes when designating beneficiaries for your 401(k) and IRA assets.
Your primary beneficiary is your first choice to receive retirement benefits. If your primary beneficiary doesn’t survive you or decides to decline the benefits (the tax term for this is a disclaimer), then your secondary (or “contingent”) beneficiaries receive the benefits. Or you can name more than one beneficiary to share in the proceeds. You will need to specify the percentage each beneficiary will receive (the shares do not have to be equal, but the total must equal 100%).
Life Insurance Beneficiary
Since life insurance policies are generally not governed by your will, the only way to make sure your policy’s benefits are distributed how you want is to make sure you’ve named a beneficiary for all of your policies and accounts.
When purchasing life insurance, most people have a specific beneficiary in mind, such as young children, spouses, or family members who rely on them for financial assistance. If you don’t designate a beneficiary, it may be unclear who is entitled to the funds, delaying the benefit payment.
Most life insurance policies have a default order of payment if you do not name a beneficiary. For many individual policies, the death benefit will be paid to the policy owner if they are different from the insured person and still alive; otherwise, it will be paid to the owner’s estate. For group insurance policies, the order typically starts with your spouse, then your children, then your parents, and then your estate. If no default order is specified in your policy, the payout may be paid to your estate or be held in probate court.
An annuity is a financial instrument that accrues interest tax-deferred and protects against market risk and longevity risk. Because annuities offer many benefits, lottery winners, retirees, and structured settlement recipients use them to create predictable cash flow for the present, future, and even after their death. Depending on the terms of the contract, annuity payments will end after the annuity owner’s death.
Annuities with a death-benefit provision allow the owner to designate a beneficiary to receive the greater of the remaining money or a guaranteed minimum. Annuity owners work with insurance companies to create custom contracts that specify payout and beneficiary options. After an annuitant dies, insurance companies distribute any remaining payments to beneficiaries in a lump sum or stream of payments. It’s essential to include a beneficiary in the annuity contract terms so that the accumulated assets are not surrendered to a financial institution if the owner dies.
Understanding what a beneficiary is and how important it is to have one designated on your financial accounts and property will protect your assets after death and ensure your family members are taken care of. When significant life changes occur, you should assess who you have listed as beneficiaries and if anyone should be added or removed.