A policyholder can — and should — name more than one beneficiary.

A planner is derelict in duty if the policyholder is not told of the privilege and advantages of naming both a primary beneficiary, which can be more than one person or entity, and one or more contingent or secondary beneficiaries.

Related: 15 legal issues every life insurance policy should address

The primary beneficiary is the first person (or class of persons) in line to receive the proceeds when the insured dies. But to be entitled to the proceeds, the primary beneficiary must be living on the date the insured dies. Otherwise, the insurer pays the proceeds to the class of beneficiary whose interest is contingent upon surviving both the insured and the primary beneficiary. This class is appropriately called the contingent beneficiary.

The policyholder may name more than one individual, entity, or combination of individuals and entities in each beneficiary class. For example, a policyholder may name his spouse if living and otherwise his two children. Where more than one beneficiary is in a given class, they typically share the proceeds equally unless the policyowner specifies otherwise in the beneficiary designation.

Policyholders can even name a third level of beneficiaries or final beneficiaries in case all beneficiaries in a higher class have predeceased the insured. Often, parents, nieces, nephews, cousins, or a charity such as a church, synagogue, or university are named at this level. Alternatively, the policyholder can designate the estate of the insured and the proceeds will become part of the probate assets where the insured’s will (or, if no will exists, the state’s intestate laws) determines the disposition.

Usually, a lower class’ rights are extinguished if the policy makes payments to members of a higher class. For instance, a contingent beneficiary will receive nothing if the primary beneficiary is alive when the insured dies. Likewise, the final beneficiary has no expectancy of a share of the proceeds if the contingent beneficiary survives the insured and the primary beneficiary predeceased the insured. Even if proceeds are taken in installments, once they are payable to a higher class of beneficiaries, any remainder payable at the death of a member of that higher class will be payable to the decedent’s estate (or contingent payee) rather than to the next class of beneficiary.

Even where it seems inherently unfair, the insurer is almost always held by the courts to be bound to pay the proceeds to the named beneficiary. There are numerous cases where the proceeds were payable to a spouse long divorced by the insured because the policyholder had forgotten to designate a new beneficiary.

Specificity is essential. The beneficiary designation should describe the person with sufficient clarity and certainty so that the insurer can easily identify the proper person, make payment, and obtain a valid release.

What follows are 11 special circumstances that may arise with beneficiaries, and advice about how to manage these particular cases.

Editor’s Note: This excerpt was taken from “Tools & Techniques of Life Insurance Planning,” which delivers detailed information about the entire range of life insurance products that can be used by estate and financial planners in a wide variety of circumstances. It includes planning techniques for retirement income needs, estate and gift tax avoidance, estate liquidity needs, and long-term care planning.

It will be less likely that a life insurance settlement is held up in probate court when beneficiearies are specifically named instead of referred to by relations such as "my wife" or "my husband." (Photo: iStock)

It will be less likely that a life insurance settlement is held up in court when beneficiaries are specifically named instead of referred to by relations such as “my wife” or “my husband.” (Photo: iStock)

1.   The policyholder has specifically named a spouse.

Courts look to the person’s name rather than description as husband or wife or fiancée. So even if that person is no longer a husband, wife, or fiancée when the insured dies, absent specific state law to the contrary, legal precedent dictates that the proceeds will still be payable to the named person. Courts do not pass on the morality of its citizens and recognize the right of the policyholder to make any beneficiary designation he or she pleases.

Related: Here are 9 ways to preempt a will contest

2.   The policyholder fails to specifically name his or her loved one.

What if the beneficiary is simply referred to as “my husband” or “my wife” without using a specific name? Here, proceeds are payable to the person who, at the time of the insured’s death, meets that description.

There are both advantages and disadvantages to this designation. Obviously, if the policyholder changes marital status, a new wife would be benefited under a “to my wife” designation. This is probably the result desired. On the other hand, the ambiguity and therefore litigation potential is significantly enhanced. The best course of action is to properly name and describe each beneficiary, back up each beneficiary with a contingent beneficiary, and quickly change beneficiary designations when marital status changes.

Naming beneficiaires can get more dicey as the client's family expands. (Photo: iStock)

Naming beneficiaries can get dicier as the policyholder’s family expands. (Photo: iStock)

3.   The policyholder names each child individually, and describes the relationship.

This is the clearest and safest approach. But a child born after the beneficiary form is signed may be excluded.

Related: Addressing beneficiaries in estate planning

4.   The policyholder names his children as a class rather than naming them individually.

The insurer may have difficulty in verifying who is included in the class, especially if name changes have occurred. The term “my children” may also cause legal problems and in many cases will include illegitimate, legally adopted, and children from a prior marriage as well as children born after the beneficiary form is signed and even those born after the insured’s death. (Note that stepchildren, and in some cases, children born out of wedlock, are not generally included unless they are specifically named in the policy.)

Related: 10 ways to screw up when picking life insurance beneficiaries

5.   The policyholder names “My Issue and Heirs.”

“Issue” is a term far broader than children and includes any lineal descendant no matter how far down the line. So grandchildren and even great grandchildren would be included. Heirs means those who would inherit under state intestacy laws (i.e., in the absence of a valid will). This designation is not generally recommended.

The choice between per capita and per stirpes is personal but often causes confusion. (Photo: iStock)

The choice between per capita and per stirpes is personal but often causes confusion. (Photo: iStock)

6.   The policyholder names a class of beneficiaries per capita or per stirpes.

A per capita (by the heads) distribution means that the proceeds will be split according to the number of beneficiaries in the class. If there are three children, each takes one-third. If there are only two out of the three that survive the insured, each takes one-half. A per stirpes (by the branches) distribution means that the distribution is first divided among the class – including a share for any predeceased member that is then split among that member’s children. If two out of three children survive, the proceeds are split three ways with the deceased child’s children equally splitting the share the deceased child would have had. (If the deceased child had left no children, the surviving two children would split the entire amount of the proceeds. It is best when making a per stirpes distribution to specify what is meant since different jurisdictions have varying interpretations of the per stirpes rule.)

Related: How to avoid beneficiary mistakes

7.   The policyholder names a minor as beneficiary.

Few states would allow payment of policy proceeds to a minor and few companies would agree to do so even if not forbidden by law because minors cannot give a valid release to the insurer. For this reason, policyholders should name a trustee as beneficiary in most cases involving minors.

Naming a guardian can cause problems because:

    • It is not certain that the guardian will survive the insured and the insured’s spouse;
    • The court may not appoint the same individual as the policyholder selected; and
    • The children may be legally competent by the time the insured dies.

Some states, such as Pennsylvania, provide for what is sometimes called a naked or informal guardian. This is a perhaps misnamed but highly useful creature of statutory law that allows a policyholder to invoke that statute in the beneficiary designation without the trouble and expense of setting up a formal trust during lifetime by appointing a guardian in a life insurance policy. Pennsylvania’s statute provides that a person may appoint a guardian of a minor or otherwise incompetent on the insurer’s beneficiary form. Payment by an insurance company to the guardian discharges the insurer to the same extent as if it made payment to an otherwise duly appointed and qualified guardian. This type of procedure is a good compromise when the total proceeds do not warrant the creation of a formal trust.

When naming a trustee as policy beneficiary, it is good practice to name a backup beneficiary in case the trust is terminated. (Photo: iStock)

When naming a trust as beneficiary, it is good practice to name a backup beneficiary in case the trust is terminated. (Photo: iStock)

8.   The policyholder names a trust as beneficiary.

This designation provides the ultimate in flexibility, by assuring that the trustee will survive the insured and spouse, and increasing the chances of proper investment management and higher returns.

Related: 6 trusts you should know about

9.   The policyholder names a corporation, partnership, limited liability company, or charity.

It is essential that the full legal name of the entity be specified.

10. The policyholder, who is not the insured, names a third party as the beneficiary.

This is common and proper practice where one party owns life insurance on the life of another. In fact, there are almost always income or gift tax problems where one party owns insurance on the life of another but makes a third party the beneficiary. We call this the “Unholy Trinity.”

11. The policyholder has failed to name a beneficiary.

Some smaller policies and group term life contracts provide a facility of payment clause that enables the insurer to pay a limited amount directly to the providers of the insured’s last illness and burial expenses. Insurers will pay most larger amounts according to the policy provisions that specify the recipient when no beneficiary has been designated (or where all primary and contingent beneficiaries predecease the insured). Selecting a beneficiary by default is obviously not the preferable manner for disposing of policy proceeds.

See also:

Changes to estate planning laws in 2016: what to expect

Addressing beneficiaries in estate planning

5 mistakes estate executors make

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