What is a beneficiary in life insurance?

Investopedia tells us that A beneficiary is any person who gains an advantage and/or profits from something. But, especially for purposes of life insurance, a beneficiary is really two seemingly identical, yet fundamentally different things:

• A person qualified to receive the proceeds of the policy.
• The person named in the paperwork.

The potential friction between these two things makes the answer to this question far more complicated than it might seem. For example, to your mind, saying “my wife” or giving her full legal name (such as “Sally Ann Smith”) may seem like the exact same thing, but they absolutely are not for purposes of creating a life insurance contract.

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Social Relationships and Legal Constructs

Generally speaking, life insurance is typically taken out by the person whose life it covers in order to provide for loved ones in the event of their demise. Understandably, many people assume that the beneficiary is a fairly straightforward matter. However, it really is not. There is a great deal of devilry in the details.

The proceeds most often go to the spouse of the insured. Sometimes, they go to the offspring of the insured. In a nutshell, the proceeds usually go to the immediate family, not just because you care the most about these people, but also because your loss is extremely likely to negatively impact their finances.

However, a combination of differences in the law from one state to another, legal consequences of casual wording and unexpected real life events adds up to many opportunities for things to go wrong.

Seemingly minor differences in wording can be the difference between a smooth financial transition upon your demise or the start of a long and costly legal battle for your relatives in the aftermath of your death.

For example, you should never use any of the following words to name a beneficiary: husband, wife or spouse. Doing so can create a huge can of worms that will suddenly come open upon the event of your death.

Instead, you should use the legal name of your spouse. This practice makes things much clearer in cases where your circumstances have changed substantially in the time between taking out the initial policy and the time of your demise.

Life happens. Perhaps when you took the policy out, it was your first marriage and your life and finances were both relatively simple. But, due to unforeseeable events, such as a divorce or even the death of your spouse, you later remarried.

Using the full legal name of the intended beneficiary avoids creating the legal question of “Who is this ‘spouse’ that is entitled to the benefits of this policy?” The word “spouse” introduces ambiguity. Does it refer to the person to whom you were married when you took out the policy? Or does it refer to the person to whom you were married when you passed away?

Even if your first spouse has died, this can be a very thorny issue. State laws, whether or not you have children with both of your spouses and even what your will says can all come together to create a perfect legal storm that can turn into a nightmare for your survivors.

This principle generalizes. Although you may only have one biological offspring when you take out the policy, it is problematic to list them as son, daughter, or child.

Over time, more people may enter your life that could fit the definition of those words. You might have more biological children. You might adopt. You might remarry and, in the process, acquire step-children.

Complicating matters further, different states have vastly different rules and regulations that impact the division of property in cases where the deceased failed to make their intentions crystal clear. For this reason, beneficiaries should always be listed by their full legal name.

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Context Matters

If you are an ordinary person with few assets, things may be relatively simple. If you have more assets, they may get pretty complicated.

The context in which this life insurance policy is being taken out has a significant impact on exactly how the beneficiary should be named.

But even if your legal and financial lives are simple, it can be more complicated than you think. Some best practices include:

• List specific names, not general relationships like “my offspring” or “spouse.”
• Find out what your state’s laws are and how they impact inheritance and distribution of assets.
• Always name at least two beneficiaries, the primary beneficiary and a secondary beneficiary.

When Life Gets Complicated

If you have substantial assets, have gotten divorced, been married more than once, have step children or any number of other complicating factors, it gets even more complicated to name your beneficiaries. Under such circumstances, it is also far more important to get it right. Otherwise, a legal battle over your estate is practically guaranteed.

If your life has diverged at all from a 1950s style nuclear family, this is likely to leave you with more complicated insurance questions rather than less complicated ones. This can be true even if it seems like it should simplify things.

For example, standard wisdom suggests that if you are single and childless, you do not really need life insurance. But, this is not necessarily true. Instead, it can introduce questions like what happens to your pets and how will your burial be covered?

But many people actually have a more complicated family situation, such as having biological children from more than one partner, step-children, adopted children and/or special needs children.

State laws may treat all these relationships as the same and equal when, perhaps, you wish to address them differently. Or the opposite can happen, where you feel they are equally “your children” for purposes of inheritance, but the law treats them differently.

In that case, you may need to seek out more consumer information or possibly consult with a professional. You do not want your loved ones to find out after the fact that your concept of family and the law’s concept of family differ in ways that will negatively impact the people you most love.

Your final wishes need to be spelled out clearly while you are still around to express them. While trying to spell them out, it may help to think of the law as being like a genie in a bottle: You need to word your wishes very carefully so they are not corrupted that won’t do what you said.

Life Insurance is a Contract

Although state laws and other factors can influence how a policy gets administered, it is a legally binding contract. It will not be overridden by your verbal instructions to relatives or even what you put in writing, officially or unofficially, elsewhere.

This makes it important to periodically revisit your insurance needs. It does not work well to set it and forget it.

Whenever you have major life events, such as getting married, having a child or getting divorced, you should at least re-read your existing policies. Do not assume they will cover your current situation adequately when they were drawn up under different circumstances.

Moving is another good reason to revisit your insurance needs. This is especially true if you change your state of residence. Laws concerning inheritance and rights of survivors can be dramatically different from one state to another, even if those states are right next to each other. This can have a substantial impact on your estate and on your insurance policies.

Insurance is a highly regulated industry. The exact same policy from the same insurance company can pay differently due to the state in which it is issued.

Be Careful, But Stay Calm

Although it is possible for things to go wrong, you can minimize the risks. Some ways to reduce the risks include using full legal names for any beneficiaries listed, revisiting your insurance needs when you have important changes, and making sure to list more than just a primary beneficiary.

There are few things more frustrating than a messy estate. Building redundant safeguards into your process will help make sure that the benefits of your policy are received by the persons you intended.

It may seem like a hassle to you to stay on top of it. But it is much less of a hassle for you to communicate your wishes clearly while you are alive than for your family and the courts to sort it out after you are gone.

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