Estate planning basics – beneficiary designations, Part 1

​As part of will and trust preparation in our estate planning practice we always ask people about beneficiaries.  Everyone says they have everything all set.  But, sometimes when we check, that isn’t quite true… as you will see, this can be a tricky area, especially with respect to life insurance.
Do you get them all right?

Part 1 – Life Insurance Beneficiary Designations

A. Whom do you name on your personal Life Insurance Policy?  The estate, a trust, or the person directly?
Some say, “Why the Estate, of course!”  Probably not!  Naming the estate creates a number of serious problems.   First, you put non-probate assets right back into probate.  This will take extra time to complete, delaying access and use of the insurance proceeds by surviving family members.  Second, the proceeds are now subject to estate taxes (if you are subject at all) regardless of who owns the policy. Third, you may lose creditor protection over the life insurance proceeds under North Carolina law, meaning that creditors might end up being able to claim some or all of the proceeds!
Perhaps you thought, “Oh, of course, the Person!”  It is better is to name the individual, but that can create different issues.  It is important to know if the individual has credit problems or is a special needs person.  In those cases, protecting the individual is essential and you should have good advice from an attorney about how to do that in your case.  If these reasons apply to your case, we suggest not naming a person directly.
If you answered, “the Trust”, then you are thinking well.  Putting proceeds into a trust means that the rules of the trust control distribution.  Leaving it to the estate could result in state rules applying if there is no will (“Intestate”), or whatever rules the Will ends up defining.  That might not be what you want or expect. Using the trust helps fix that.  If you have a trust that generates income, diverting income to pay for a life insurance policy owned by the trust can be a wise idea.  And, you can protect the special needs person through use of a properly drafted trust.
We usually suggest that naming a stable individual for a personally-owned policy, or the trust for a trust-owned policy or an individual needing protections, is the right answer.
B. Whom do you name on as Beneficiary of your Business-Owned Life Insurance Policy?
Now that you know about personal policies, what about the business policies?
Businesses often purchase life insurance on the life of owners or key employees to fund buy-sell, business continuation arrangements, or executive benefits.  Unfortunately, for many reasons (typically related to expediency, cost savings, or ignorance of the law) many folks assume that family members of the insured should be named as beneficiaries.
What is wrong with that?  Instead of receiving the insurance proceeds income tax-free, the proceeds may be considered taxable income to the beneficiary either as ordinary income or as a dividend.  For business owners, payment to an individual could result in what’s known as a “transfer-for-value,” which may make the insurance proceeds taxable.  The beneficiary of a business-owned policy should always be the business.
C. What if your children are still young?  Can you name a Minor Child as Beneficiary to a Life Insurance Policy?
This one is easy!  No, you should not name a minor child as a beneficiary.
Insurance carriers won’t pay benefits to a minor.  Designating a minor as the beneficiary may lead to court proceedings to designate a guardian or trustee to receive the proceeds.  As in the probate explanation above, naming a minor delays access to the insurance policy proceeds and causes unnecessary legal and administrative expenses.  If you want your minor child to be a beneficiary of anything, then let us help you construct a proper trust.
D. What about “contingent” beneficiaries?  Do you need them?
Yes!  Every financial product that allows for a beneficiary designation should have primary and secondary (contingent) beneficiaries.  This helps to ensure that the asset goes to whom the decedent intends, even if the primary beneficiary predeceases the decedent… which is a complicated way to say that you need to plan for a backup.
If you only name your daughter Susie as your beneficiary and she dies before you do, what happens to the funds you wanted to give her? Without a backup, your plan may fail because the asset will be included in the estate, requiring probate or intestate administration.  This will result in delayed access to funds and unnecessary legal and administrative fees.
Always have contingent beneficiaries.  Check with your insurance provider, and your investments and banks, before you forget!
When you visit your estate attorney, be sure that you discuss your entire estate plan, including lifeinsurance, ​and make changes you need to the beneficiaries.
The next parts of this series of three will cover some other basic beneficiary issues we see in estate planning.

Ratings and Reviews

Top Attorney​, 2015-2016​