When a person dies who is the insured subject of a life insurance policy, the family members who are beneficiaries have the responsibility to contact the insurance company and make a claim for the payment of death benefits. Normally, this is a fairly simple procedure, and claims are paid quickly. However circumstances do arise which complicate the process, such as when one of the beneficiaries dies prior to or just after the policyholder.
Let us consider several scenarios and the implications of each.
First, suppose the beneficiary dies prior to the insured person, by a matter of days, weeks, or months. If the insured person does not contact the life insurance company and change the beneficiary to another person, severe complications can result. There may be no one listed to take the proceeds of the life insurance, and the insurance company may not know to whom to pay the money. The resulting probate issues could take up weeks or months of time, delaying payment of the insurance proceeds and costing money in fees and taxes.
If there are other beneficiaries to take the proceeds, the insurance company will usually distribute the money among them according to the terms of the policy. Generally speaking, the proceeds of the deceased beneficiary’s share of the policy will be divided and distributed according to whatever percentage or term each beneficiary was to receive under the policy. If a spouse was to receive fifty percent of the proceeds, for example, and the children the remainder in equal amounts, the spouse’s share will be distributed equally among the children if the spouse dies prior to or just after the insured individual.
However, if there are no other beneficiaries listed on the policy, the insurance company will generally pass the policy proceeds into the insured’s estate. This can have definite tax and legal consequences. The proceeds will be added to the sum total of the estate’s value, and will be divided according to the deceased person’s will, or according to prevailing state law if the person died intestate (without a will). In some cases, state law will prevail and the insurance company will be forced to comply with the law regarding distribution of assets to family members, no matter what the company’s normal policy.
A second scenario is one in which the insured and the beneficiary die together or so close to the same time as to be practically simultaneous. In fact, many insurance policies have a “survival clause” that states that the beneficiary must survive the insured for a certain period of time, or they will be considered to have died simultaneously. If the beneficiary does not survive the insured by at least this time period, the same situation arises as if the beneficiary had died first—the proceeds of the policy may be divided among the remaining beneficiaries or placed into the insured’s estate and subject to taxes and probate costs.
A third scenario is when the beneficiary survives the insured, but at some point weeks or months later, during the probate process, the beneficiary dies. At this point, if the life insurance proceeds have already been distributed, the beneficiary’s share becomes part of his or her estate, and subject to whatever terms exist under a will or under state law. This money can be taxed just as other property by the probate court or the federal or state governments under inheritance tax laws.
There are a couple of ways to prevent these scenarios from plaguing your survivors with problems and expense. First, it is always wise to have secondary beneficiaries for a life insurance policy. While you do not want the life insurance proceeds to pass under your will—making them subject to inheritance tax and probate costs—you will want to provide for each of your heirs under whatever circumstances apply at the time of your death. Many policies will allow you to list secondary or even tertiary beneficiaries in the event of the death of one of your primary beneficiaries. Also, review your policy to understand exactly what happens if one of your beneficiaries dies around the same time as you.
If a beneficiary does die prior to you, it is very important to update your policy. This is not usually a complicated process; often, you must simply sign a form that adds a new beneficiary. While grieving families often do not think of this step, it can be crucial in saving your loved ones unneeded expense and problems in the future. Talk to your agent immediately to discuss the status of your life insurance beneficiaries and ways to protect them.