When you apply for a life insurance policy, one of the questions on the application will be concerning who you would like to be the beneficiary of your policy, which means that they’ll get the death benefit when you pass away. It’s an important decision that will have a dramatic financial impact on the person you select.
Jump ahead to these sections:
- What’s a Life Insurance Beneficiary Rule?
- Life Insurance Beneficiary Rules for Spouses
- Life Insurance Beneficiary Rules After a Divorce
- Life Insurance Rules If the Beneficiary Died
In this article, we’ll look at what a life insurance beneficiary rule is, the rules for spouses, the rules after a divorce, the rules if the beneficiary has died before the insured does, and how to determine if you need life insurance.
What’s a Life Insurance Beneficiary Rule?
A life insurance beneficiary rule is a rule put in place either by the life insurance company or the insurance commissioner of the state you live in.
If you’re married or have children, it’s important that you know what these rules are. If you’re single and don’t have children, you are free to name anyone that you want as your beneficiary.
Life insurance companies don’t make moral judgments when you name a beneficiary. In most states, you don’t have to name a spouse. You can name adult children, a business partner, or even a secret lover outside the marriage. In most states, the life insurance company will simply pay the death benefit to the named beneficiary when they submit a claim.
There are exceptions, though, which we’ll look at below.
Life Insurance Beneficiary Rules for Spouses
It occasionally happens that a married person finds out after their spouse died that they weren’t the beneficiary on that spouse’s life insurance policy. Many long legal battles have ensued after this has happened. Still, it’s not a hard decision for the judge because the laws are pretty clear concerning who can and can’t be named the beneficiary of a life insurance policy.
Let’s take a look at what spouses need to know about life insurance beneficiary rules pertaining to them.
Rule 1: Spouses are protected in community property states
Under most circumstances, a spouse doesn’t have any right to submit a claim and be paid life insurance proceeds if someone else is named the beneficiary, unless they live in a community property state.
A community property state’s laws stipulate that both spouses equally own any income earned during the marriage and any property purchased with that income—including life insurance policies. There are nine community property states. They are:
- New Mexico
Alaska and Tennessee are “opt-in states,” meaning that spouses can opt in and participate in their state’s community property laws.
For example, in the state of Texas, if a spouse uses community property, like income they earned when married, to pay the life insurance premiums, their spouse has the legal right to a portion of the death benefit.
The amount of the death benefit they’re entitled to depends on the type of policy they have—term life insurance or permanent life insurance.
With term life insurance, the entire policy is considered community property if the couple was married when the policy was issued. With permanent life insurance, like whole life or universal life insurance, the proceeds are prorated according to the percentage of premiums paid with earnings received when they were married (community money).
For example, if someone is issued a life insurance policy, pays the premiums with their own money, and is married two years later, if they die after being married one year and have named someone else as beneficiary, their spouse would have the legal right to 50% of one-third of the death benefit paid out.
Rule 2: The spouse can be excluded if they so desire
What happens if someone wants to leave the entire death benefit to someone else other than their spouse in a community property state? It can be done.
Spouses can sign a “property status agreement” that states the life insurance policy is not community property; it’s separate property. In some cases, the insurer can require that the non-insured spouse sign a form stating that they consent to waive their rights to the death benefit.
Without signing the property status agreement, a spouse's waiver of receiving half of the death benefit could be ruled as a gift by the IRS, triggering an estate tax or gift tax burden on the surviving spouse.
When there’s a blended family and both spouses have children from more than one marriage, beneficiary decisions can get tricky. If this is the case, it’s a smart move to consult an estate attorney about your situation.
Rule 3: A spouse can contest being excluded when their spouse isn’t mentally competent when naming a beneficiary
It sounds like a plot out of a movie, but family members have been known to take advantage of a senile parent and get them to change the beneficiary of their life insurance policy.
If this is the case, a person could argue that their spouse wasn’t mentally competent when they made the change, leaving it up to a judge to decide the suit's outcome.
For example: John is 88 years old and has recently been diagnosed with Alzheimer’s disease. The majority of the time, he is lucid and carries on conversations like he always has. However, sometimes he gets forgetful about people’s names and where he is.
John owns a life insurance policy and has named his wife Mary as the beneficiary. Their son David has John change the beneficiary to be David, without Mary’s knowledge. When John passes away, and David lays claim to the death benefit, Mary could contest this and show that the date John signed the change of beneficiary form was after he had been diagnosed with Alzheimer’s disease. It’s quite likely that Mary would prevail since John was not in possession of 100% of his faculties when he signed the change of beneficiary form.
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Life Insurance Beneficiary Rules After a Divorce
It can get messy when a piece of property like a life insurance policy is dealt with when a couple divorces, especially when there are children involved. Beneficiary changes often need to be made; sometimes it’s easily done, and sometimes it isn’t. Here are some rules that apply to this situation.
Rule 1: In a non-community state, beneficiaries can be changed in a divorce, if the judge approves
To illustrate this rule, let’s use a situation involving Peter and Ruth.
Peter and Ruth have been married for eight years and have three children: 2, 5, and 7 years old. They live in a non-community property state and are going through a divorce. They both own life insurance policies on the other spouse’s life and are the beneficiaries of those policies.
Peter makes it known that as soon as the divorce is finalized, he will change the beneficiary of his policy to be his brother. Ruth becomes aware of this and tells her attorney about it. The attorney petitions the judge to legally require Peter to leave Ruth as the beneficiary until their youngest child turns twenty-one so the death benefit can go towards their care and educational expenses. The judge will likely make this part of the final divorce decree.
If there were no children in the marriage and no extenuating circumstances, Peter would have the legal right to change the beneficiary to whomever he wanted.
Rule 2: In a community property state, how long a couple is married determines the death benefit payout to the former spouse
It gets more complicated in a community property state. Using the example above, let’s say Peter and Ruth lived in Washington, a community property state. They were married for five years and had no children. Peter took out a $100,000 life insurance policy and named Ruth as the beneficiary. They got divorced after five years, and Peter was then married to Paula for five years. Peter changed his policy beneficiary to Paula when they got married.
Peter then passed away. Because Washington is a community property state, Ruth would claim 50% of the death benefit because she was married to Peter half of the time he had the life insurance policy, and the premiums were paid with community money. Paula would be paid the other 50% because she was named as the beneficiary of the policy.
Life Insurance Rules If the Beneficiary Died
Once again, we have a bit of a complicated situation if the beneficiary on the policy has died. Two rules need to be considered in this instance.
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Rule 1: If the primary beneficiary has died before the insured dies, the contingent beneficiary gets the payout
When taking out a life insurance policy, you name two beneficiaries: the primary beneficiary and the contingent beneficiary. The primary beneficiary is the main beneficiary; the contingent beneficiary can also be considered the secondary beneficiary.
If the primary beneficiary passes away before the insured, the secondary beneficiary will receive the death benefit. It’s very straightforward.
Rule 2: If both beneficiaries died before the insured, the estate receives the death benefit
If both beneficiaries predecease the insured, then the insured’s estate will receive the death benefit. This isn’t good news because the estate will go through probate, and the life insurance death benefit payout will be delayed during this lengthy and expensive process. If a trust had been named as a third beneficiary, probate for the life insurance payout would have been avoided.
Tips for Determining If You Might Need Life Insurance
Not everyone needs life insurance. Before talking with a life insurance agent, who’ll likely tell you that you need life insurance, consider these tips to help you decide if you need it.
- You need it if someone is dependent on you for financial support.
If you have a spouse and children that couldn’t maintain their lifestyle or stay in their home without your paycheck, you need life insurance.
- You need It if you own a business and have partners.
A partnership should have a “buy-sell agreement” in place so one partner can buy out the other if one partner dies. Life insurance can fund this buyout.
- You need life insurance if you have a lot of debt.
If you have student loans, car loans, installment loans, or any other type of debt, your life insurance policy can be used to pay off those debts, so your survivors aren’t saddled with them.
As you can see, life insurance beneficiary rules and how they affect payouts can be complicated. A good estate attorney can provide you with guidance on how to designate the beneficiary of your policy, particularly if you live in a community property state.
Having an attorney review your policy and beneficiaries is worth the expense now rather than having your intended beneficiary pay extensive legal fees in the future.