Linas Sudzius, with Advanced Underwriting Consultants, has seen many problems generated form improper, inadequate or outdated beneficiary designations. Please read his article below which addresses some common beneficiary errors. It is a good reminder for all of us to remind our agents to think about proper beneficiaries at policy issue and the importance of beneficiary review during regularly scheduled policy review meetings:

Mistakes in Beneficiary Designation

The single biggest category of life insurance mistakes is with in the realm beneficiary designations. While the beneficiary errors discussion centers around life insurance, each of the beneficiary designation observations could also apply to some extent to pension accounts, IRAs or non-qualified annuities.

Mistake One: The Insured’s Estate Has Been Named Beneficiary

Very few life insurance applications explicitly name “estate of the insured” the beneficiary of the death benefit. However, most life insurance companies default to the insured’s estate when no specific beneficiary is listed.

What’s wrong with naming the estate the beneficiary—either explicitly or by default?

If the estate is the beneficiary, the access of the heirs to any money associated with the financial product is delayed because the money must go through probate. With probate, in some cases, the delay can be a year or more. Any asset forced through the probate process becomes part of the public record, so privacy is lost. Perhaps most importantly, in most jurisdictions the life insurance money becomes subject to the claims of creditors of the decedent’s estate—a situation that does not exist where there is a named beneficiary.

If the decedent has no valid will at the time of death, the intestate rules of the state of residence at the time of death will dictate who will be entitled to the death benefits. Will the state’s default provisions match the decedent’s intentions? In many cases, the answer will be no.
Finally, in some states, Ohio for example, failing to name a specific beneficiary for a life policy may cause the benefits to be subject to state estate tax. In Ohio, that may mean up to 7% of the death benefit could be lost unnecessarily.

Mistake 2: The Policy Has No Named Contingent Beneficiaries

A substantial percentage of life insurance applications have had no named contingent beneficiary or beneficiaries.

Why is that a problem?

If there’s no named contingent beneficiary, and if the primary beneficiary has predeceased the insured, in most cases the insured’s estate will be the default beneficiary. That leads to all the drawbacks described in mistake number one.

It’s a best practice to always name contingent beneficiaries. Some more sophisticated producers even go so far as to name a second set of contingent beneficiaries, in case both the primary and contingent beneficiaries have pre-deceased the insured.

Mistake Three: Minors or Other Impaired Persons Have Been Named Beneficiaries

Say that Tom and Katie, a married couple, each want to buy insurance on their lives. Tom will own the coverage on his life, naming Katie the beneficiary. Katie will own insurance on her life, naming Tom the beneficiary. Each of them names their daughter Suri as the contingent beneficiary.

Assume that Suri is only five years old. If something happens to both Tom and Katie in the next few years, and Suri is entitled to the money, she will not be old enough to exercise legal control over it. In most cases, a court-supervised guardianship or conservatorship will need to be created for the benefit of the minor.

The process of creating a guardianship or conservatorship usually requires a legally responsible adult to file a petition with the court to seek permission to act. If family members are not in agreement with regard to who should act, the court proceeding could be contested. The cost of a family fight could deplete assets otherwise available for the minor.

Once selected by the judge, the guardian or conservator will have numerous duties and responsibilities with regard to taking care of all of the minor’s needs. The fiduciary will likely have to seek the court’s prior approval for many actions, increasing costs and creating delays.

What’s the alternative?

If Tom and Katie have created a testamentary trust for Suri’s benefit inside of their will or living trust documents, then that trust may be named contingent beneficiary of the life proceeds. If no such trust has been created, the parents may decide to let Jack, a close family friend, hold the money on Suri’s behalf, using a ready-made custodianship under the Uniform Transfers to Minors Act (UTMA).

In the example, even if Suri is 25 instead of five, it might be a mistake to leave her a substantial life insurance death benefit. It is clearly imprudent to pay a lump sum of almost any amount to a spendthrift child, even if that child is technically an adult. Further, even if a beneficiary is not a spendthrift, it may be wise to force large sums of money to be managed by a professional on the beneficiary’s behalf. That’s where a trust as beneficiary might also be helpful.

When a potential beneficiary is collecting needs-based government benefits, if that beneficiary collects funds from a life insurance policy it may make those benefits stop. The best course might be to leave funds to a special needs testamentary trust for the benefit of that beneficiary. Such a trust, properly drafted and administered, can give the beneficiary some access to funds while also allowing benefits to continue.

How can an insurance professional tell whether a client has minors named as beneficiaries, or whether the beneficiaries are financially impaired? Ask the client!

Mistake Four: The Beneficiary Language is Wrong or Unclear

Let’s say that Ann Romano names her adult daughters, Barbara and Julie, each 50% beneficiaries of Ann’s life insurance policy. Where will the policy proceeds go if Barbara passes before Ann, then Ann dies before making any adjustment to the beneficiary designation?

Many insurance companies will send the death proceeds to the sole surviving beneficiary—in this case it would be Julie. But is that what Ann would have intended? What if Barbara left two children—Ann’s grandchildren—as survivors? If Julie is the unintentional sole beneficiary, Barbara’s children would be excluded from sharing in the death benefit.

In a case like this one, where fractional parts of the death benefit are earmarked for different beneficiaries, a financial professional should seek clear direction from her client regarding distribution intentions if one of the beneficiaries are pre-deceased.

If Ann, in the example, wanted her daughters to be equal beneficiaries, but wanted a pre-deceased beneficiary’s children to get their parent’s share, the beneficiary designation might read like this:

One fifty percent (50%) share to my daughter Julie Cooper, and one fifty percent (50%) share to my daughter Barbara Cooper. If one or more of these beneficiaries shall pre-decease me, the amount designated shall be distributed per stirpes to the pre-deceased beneficiary’s living issue, if any, otherwise surviving beneficiary(s) shall share in the same proportions.

About Stephanie

Stephanie is the 3rd generation of Shaws to work for Shaw American. After graduating from Indiana University in 2011, Stephanie quickly found that life insurance was her true calling.

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