What is one thing that most married people have in common?
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They want to take care of their spouse in every way possible. A life insurance policy allows a spouse to take care of their significant other even after they are dead. This includes covering costs related to medical bills, funeral expenses, and legal fees. The sum of the insurance policy is paid to the beneficiary of the deceased, which may be a spouse, a boyfriend, a girlfriend, or a child.
This brings up two crucial questions which raise additional subjects of their own:
First, who should you choose as the beneficiary on your life insurance policy? Is it better to choose a spouse or a child? Can you select a beneficiary without their consent?
Second, what sort of rights does that beneficiary have regarding the payment? For example, what if a deceased husband had forgotten to update his policy from his ex-wife to his current wife? Could the current wife dispute the claim of the listed beneficiary?
These are all critical questions. You should fully understand them and have something close to an answer before signing the dotted line.
Let’s start with a straightforward question that you may be asking yourself if you’re married:
Is My Spouse Automatically a Beneficiary?
The short answer is: No. Most states allow a person to name whomever they choose as their beneficiary. Texas, Washington, Alaska, Wisconsin, Louisiana, California, Alaska, Idaho, and New Mexico are all community property states.
A life insurance policy created after marriage is considered marital property in these states. The spouse must approve the selection of the beneficiary and any future changes. Similarly, if an ex-spouse is named as the beneficiary, the current spouse may be able to dispute the claim. They may even be entitled to a small percentage of the policy.
Next, let’s assume that you either don’t live in a community property state or, if you do, then your spouse will approve your choice of beneficiary. Who should you choose? Is there ever a reason to choose anyone other than your spouse?
Who To Choose As Your Beneficiary?
You have quite a few options when it comes to choosing your beneficiary. Some of the most common choices include:
Some people even go as far as to name the person they are having an extramarital affair with. We’re not saying that you should do that. Only that the choice of yours. But which of these should you choose?
The ideal beneficiary candidate is someone who is currently dependent on you for financial support. If someone is financially dependent on you, then they are going to face hardships when you die. The payout from a life insurance policy will help them overcome those hardships while also handling the various funeral and medical fees.
For most married people, the spouse is the ideal candidate because one spouse is financially dependent on the other. This is particularly true in households where only one spouse has an income. Life insurance becomes a security net for when that spouse dies, and that income goes away.
A spouse isn’t the only person who may be financially dependent on you. Children are a great example of a close family member who may rely on your income. Most married men and women would instead leave the policy in the hands of their spouse than their child. There are certain situations where it would be better not to do so. A great example is a marriage where the husband and wife are estranged or separated.
A single parent will face unique obstacles when choosing a beneficiary:
In 2018, roughly 41 percent of unmarried mothers in the United States were covered by a life insurance policy. If the child is under the age of 18, then they cannot receive the payout from a life insurance policy. Instead, the parent chooses a trust as the beneficiary. The trust passes the funds along to the child when the time is right.
Leaving the payment to a legal guardian on behalf of a minor will require additional legal steps. The court will need to appoint the new guardian following the death of the parent.
A couple of additional possible scenarios include naming an estate as a beneficiary and naming a charity as a beneficiary. Both of these require additional steps and involve different legal practices. Who you choose as your beneficiary not only affects who receives the money but also how taxes will be paid on those earnings. The tax-specifics should be discussed in-depth with a professional accountant.
Whether or not you can change the beneficiary in the future depends on their classification:
The first classification is a revocable beneficiary. This means that you are allowed to change the recipient on the policy at any given time. You do not need the permission of the existing beneficiary to make this change.
The second classification is an irrevocable beneficiary. You cannot change the beneficiary on this type of policy without the consistent of the existing one. A spouse and beneficiary in a marital property state can be considered an irrevocable beneficiary.
Revocable vs Irrevocable beneficiary?
In general, a revocable beneficiary is the better choice if available. It’s easier to adjust your policy in the future and your risk fewer legal challenges. However, some couples prefer to be irrevocable beneficiaries as a sign of trust. You’ll need to discuss the pros and cons of both options with your spouse. Of course, depending on your state, you may not have a choice.
This leads to the next big question:
How does a divorce impact the designation of beneficiaries?
On the surface, divorce does not have any immediate or severe impact on a life insurance policy. It will not automatically change the owner, the insured party, the insurance provider, or the beneficiary. However, for obvious reasons, you may want to remove them as the beneficiary following the divorce manually. This is entirely within your power as long as the judge doesn’t issue any orders regarding the policy.
There are cases where a judge may order someone to keep their ex-spouse as their beneficiary. This is most common with full life insurance policies that have an actual cash value. If you owe alimony or child support, then the value of the policy may be used to offset these expenses.
What if you pass away before updating your beneficiary from your ex-spouse to your current spouse? In most states, that ex-spouse is still entitled to the payout because they were never removed from the contract. Thus, you must update your policy promptly following a divorce.
Laws in community property states:
The laws are a bit different in community and marital property states. Even if you forget to update the policy to your current spouse, that policy is considered marital property shared by you and your current spouse. That would mean your current spouse is entitled to 50% of the value of the policy even if they are not listed as a beneficiary.
Your current spouse will have some legal options if you forget to update the policy in a non-marital property state. They can file a dispute with the policy, which will then be frozen by an IRA custodian. The court will eventually provide a ruling on the dispute, and the IRA custodian will oblige. It’s a complicated legal process that is best avoided.
Having Multiple Beneficiaries
You can have more than one insurance policy or more than one beneficiary. Naming multiple beneficiaries within a single policy is common when creating policies intended to benefit your surviving children. For example, if you have a son and a daughter, then you may want to leave 50% of the policy to each child.
One way to do this is with the per stirpes method. In a sense, you designate entire branches of lineage as beneficiaries. The son and daughter from the previous example would be the first tier of the branch. But what if the son passes away before you do? The title of the beneficiary would then be passed further down the branch to his children. The fifty percent that he would have received is now applied equally to his descendants.
A second option is the per capita method.
With this policy, the payout is divided among all survivors within your line of lineage. This would include your children, their children, and so on. Per capita policies are more comfortable to organize and manage.
Ensuring Your Family Is Cared For
At the end of the day, a life insurance policy is all about making sure your loved ones are cared for after you are gone. Who is going to need that care the most? Will it be your spouse, your children, or another close family member? Or perhaps each of these individuals needs some form of financial security divided among different policies. There’s no single solution that works best for everyone.
Discuss your options with the people that matter:
- Your spouse
- Your parents
- Your accounts and lawyers
Investing in life insurance is undoubtedly a brilliant decision. Even so, it pays to be careful and to seek advice. Now that you know the answers to some essential questions, you’re one step closer to making the right choice.