4 Common Life Insurance Beneficiary Designation Mistakes to Avoid

Purchasing life insurance is a fundamental aspect of estate planning, and when executed properly, it serves as a key method to express "I love you" to your loved ones after your passing. Nevertheless, when designating beneficiaries for your policy, certain errors can result in potentially severe outcomes for those you intend to protect and support.

Here are four common mistakes I frequently observe clients make when choosing life insurance beneficiaries.

01 - Not Designating A Beneficiary

While it might seem like common sense, many people either neglect to name a beneficiary on their life insurance policies or mistakenly designate their “estate” as the beneficiary. Both of these mistakes result in the insurance proceeds having to go through probate.

During probate, a judge decides who will receive your insurance death benefits. This process can delay the distribution of benefits for months or even years, depending on the legal beneficiaries of your estate. Additionally, probate exposes the proceeds to creditors, which can significantly reduce or even completely exhaust the funds.

To avoid having your insurance proceeds go through probate, ensure you designate at least one primary adult beneficiary. In the event that your primary beneficiary predeceases you, it's wise to also name a contingent (alternate) beneficiary. For maximum protection, consider naming more than one contingent beneficiary in case both your primary and secondary choices pass away before you.

Ideally, we often suggest that the primary beneficiary of your life insurance should be the Trustee of a well-structured Trust Agreement to offer the greatest benefit and protection for your heirs.

02 - Neglecting To Update Beneficiaries

While neglecting to designate any beneficiary is a significant oversight, failing to keep your beneficiary designations current can be even more detrimental. This is especially important if you are in a subsequent marriage and do not remove an ex-spouse as a beneficiary, which could result in your current spouse receiving nothing upon your death.

To avoid this, it is advisable to review your beneficiary designations annually as part of a comprehensive review of your estate plan and promptly update your beneficiaries following events like divorce, deaths, and births. We have integrated systems to ensure that your beneficiary designations (along with all other documents and decisions in your plan) are regularly reviewed and updated.

03 - Naming A Minor (Or Their Guardian) As Beneficiary

While you can technically designate a minor child as a beneficiary of your life insurance, it is generally unwise. Minor children cannot access insurance benefits until they reach the age of maturity, which can be up to 21 in some states. If a minor is named as a beneficiary, the insurance proceeds will be managed by a court-appointed custodian, who will oversee the funds (often for a significant fee) until the child reaches maturity. At that time, all benefits are given directly to the beneficiary without protection.

This situation applies even if the minor has a living parent. A living parent can request the court to become the custodian. However, there is no assurance that a parent will be appointed, especially if they cannot qualify or afford a bond. In several instances, a court might find a parent unsuitable (due to poor credit, for example) and instead appoint a paid fiduciary to manage the funds.

Instead of naming a minor as a beneficiary, you might consider naming the person chosen as your child's guardian. However, this is also not advisable. In this scenario, all insurance proceeds would be paid directly to the named guardian, who could use them at their discretion, or the funds could be at risk in a divorce or from a judgment creditor of the guardian.

The best approach is to establish a trust to receive the insurance proceeds and appoint a trustee to manage and distribute the funds to a minor child you wish to benefit from your insurance, according to your specifications. This way, the funds can be protected and controlled by your beneficiary, safe from divorce and creditors, if desired.

04 - Naming an Individual with Special Needs as a Beneficiary

While a loved one with special needs might be one of the first individuals you consider as a beneficiary of your life insurance policy, this decision can lead to unfortunate outcomes. Directly naming someone with special needs as a beneficiary may disqualify them from receiving essential government benefits.

Instead of naming a person with special needs as a beneficiary, you should establish a “special needs trust” to receive the insurance proceeds. This ensures that the funds do not go directly to the beneficiary after your death but are managed by a trustee you appoint, distributed according to the trust's terms, and do not impact benefit eligibility.

The regulations surrounding special needs trusts are complex and differ significantly from state to state. If you have a child with special needs, meet with me today to explore your options. Ultimately, special needs planning encompasses much more than life insurance — it’s about ensuring a lifetime of care and protection.

Avoid Future Issues Today

Designating beneficiaries for life insurance may appear straightforward, but without caution, you could inadvertently cause significant issues for the loved ones you intend to help. It's crucial to ensure everything is done correctly. I can assist you with planning tools, such as trusts — whether special needs or not — to ensure your insurance proceeds offer the greatest advantage to your beneficiaries without any negative impact.

This article is a service of the Law Office of Keoni Souza, an estate planning law firm in Honolulu, Hawai`i. We don’t just draft documents; we ensure you make informed and empowered decisions about life and death, for yourself and the people you love. That is why we offer a Family Wealth Planning Session, during which you will get more financially organized than you have ever been before and make all the best choices for the people you love. You can begin by contacting our office today to schedule a planning session and mention this article to find out how to get this $750 session at no charge.

Disclaimer: All information on this website is for informational purposes only and is not legal advice. You should contact an attorney trained to work with families on estate planning matters regarding your specific situation. Use of and access to this website or any of the email links contained within the site do not create an attorney-client relationship between the Law Office of Keoni Souza, LLC, and any users or any other party.