Who Should be the Beneficiary of Your Life Insurance?

Life insurance is an integral part of financial and estate planning for many.   In most cases, people purchase life insurance in order to protect their spouse, children, and/or others who are financially dependent on them from becoming indigent in the event they die. However, we often have questions as to how they should list their beneficiary designations on life insurance; should the individual you wish to protect be named directly as a beneficiary, or should you name your trust as the beneficiary of the policy?
In the context of retirement plans, we usually want the spouse to be directly named as a beneficiary, but the same rule does not necessarily apply to life insurance as it depends on your circumstances and goals. In determining how to designate your beneficiaries for life insurance, the fundamental questions are who are the people you trying to protect, and would it provide more protection to have those life insurance proceeds pass according to the rules and conditions set forth in your trust.
The reason for naming a trust as the primary beneficiary is that, upon your death, the life insurance proceeds would be payable to your trust, and subject to the rules of your trust. This can be very beneficial if you want to place conditions and restrictions on the distribution of life insurance proceeds. On the other hand, if you name an individual directly as the beneficiary of your life insurance policy, then upon your death, that individual receives the entire proceeds of the life insurance payout without conditions or restrictions.   In many cases, naming the trust as the beneficiary provides significantly more planning opportunities. For example:

  • Minor Beneficiaries.   If the primary beneficiaries you wish to protect are minors. Life insurance companies will generally not pay life insurance proceeds to minors. Moreover, if a minor is the named beneficiary on the life insurance policy, a guardian would most likely have to be appointed by the court following the death your death to manage the payout.   This not only entails additional delay and legal expense, but you may disagree with who the court would appoint as the guardian, as well as the underlying laws that would govern how this guardian will manage this financial windfall for the minor?   Having a well-designed estate plan gives you this control to actually name the guardians you wish to be appointed, and to specify how you wish this financial windfall to be managed or distributed for the minor’s benefit.
  • Beneficiaries with Special Needs. If the primary beneficiaries have special needs, are disabled and/or receive government benefits, getting a huge windfall from a life insurance policy could jeopardize their eligibility for government benefits. In these situations, it is usually better to have the insurance proceeds paid to a trust that can take into account these special needs so that the insurance proceeds can serve as a resource for individual(s) with special needs, yet preserve their eligibility for government benefits.
  • Financially irresponsible beneficiaries.   One of the primary benefits of using a trust for estate planning is the ability to determine how, when, and on what conditions a distribution can be made to the beneficiary. If the individual(s) you are trying to protect is not financially responsible or is a spendthrift, then, for example, you can restrict distributions to be used only for the health, maintenance, or education for the beneficiary, or condition distributions to the beneficiary only if he/she meet certain goals you wish to see the beneficiary achieve, such as education, career or rehabilitation.
  • Multiple Beneficiaries. Naming a trust as beneficiary is also useful if there are multiple individuals you wish to share the proceeds from life insurance, for example, if you have multiple children. On the other hand, if you only have single beneficiary you wish to protect and you have no issues with leaving them the proceeds outright, then it may be okay to name them as the primary beneficiary. Regardless, you should always consider naming other beneficiaries, for example, your trust, other relatives, or charities as secondary or contingent beneficiaries in case the primary beneficiary predeceases you.

For a summary regarding several other benefits of a Revocable Living Trust, here is a video from the senior partner of our firm, Mark J. Kohler:

Finally, a word on life insurance and asset protection. Every state and the District of Columbia has varying exemptions that protect the death benefit and/or cash value of life insurance. Some states like Florida and Texas have strong blanket protection against creditors for both the death benefit and cash value of life insurance. Other states have limitation on the exemption, for example, limiting the exemption to a specific dollar amount, limiting the exemption to that which is reasonably necessary to support the beneficiary, or limiting the exemption only to certain designated beneficiaries (e.g. spouses and/or children).
If protecting your life insurance from creditors is important, then you need to know the different exemptions that apply in your state and/or consider whether it is advantageous to move to a state that has better exemptions.   Better yet, if asset protection or estate taxes (either federal or state) are an issue, then you may want to consider the additional benefits of a properly structured irrevocable life insurance trust (ILIT). A discussion of ILITs is beyond the scope of this article, but if asset protection for life insurance is a goal, you need to make sure you explore this option BEFORE the need arises in order to avoid fraudulent transfer issues.
For many families, life insurance is a significant, if not largest asset in the family estate. Making sure you understand your purposes and/or options with respect to handling your life insurance will help ensure your loved ones are protected in the event of your passing.