In simple terms, a life insurance beneficiary is a person who is entitled to receive the death benefit. There is no hard and fast rule that only your spouse or children can be named as your life insurance beneficiaries. There is always a possibility to make changes if life throws a situation. Life insurance is a contract, and like all contracts, it has some rules that are to be followed.
So, here’s the question: is a husband or wife automatically entitled to be the beneficiary of your life insurance policy? Essentially, do they have a legal right to your money just by virtue of being your spouse? The question comes up from time to time so we wanted to break it down with the answers and specifics as to why.
Let’s begin with what an insurance policy actually is. It is a legal and binding contract between the policyholder and the insurer who agrees to honor the terms of that agreement and pay the proceeds to the named beneficiary in the policy upon the insured’s death. That is the insurance company’s only legal obligation, the insured person’s marital status notwithstanding. The carrier has no say in your beneficiary selection or moral judgment in agreeing to someday pay that person your insurance payout after your death.
Marriage is also a legal contract between two people. It gives spouses many rights and protections, some of which vary from state to state. But for the most part, a husband or wife has legal rights to marital assets, and in some states such as California, marital property is divided equally 50/50 if you divorce. In Florida, it’s not split down the middle but provides couples the right of Equitable Distribution. Same-sex marriages are afforded the same state and federal protections since it became the law of the land in 2015. You would think that a spouse would have an automatic right to your insurance money just by virtue of being married. But that is not necessarily the case. While that husband or wife agrees to honor the marriage bond, he/she is not legally entitled to be your life insurance primary beneficiary, or has any legal claim to the insurance money, in most states, that is. Yes, the state you live in does matter.
Why? Because there are exceptions in the Community Property States where a spouse is legally entitled to 50% of the life insurance proceeds even if he/she is not a named beneficiary in the policy. As long as the insurance premiums are paid for with joint marital assets, the spouse has legal standing to claim half of the insurance payout when the policyholder/spouse dies. We’ll provide a list of the nine “Community Property Law” states below, and incidentally, California is one of them.
It’s worth repeating that a policy owner— who also pays the policy premiums– has every right to choose whomever they want as their life insurance beneficiary. It would seem counterintuitive to designate someone other than a spouse but you never know. It is not uncommon that the insured keeps separate policies to benefit different people. For instance, a policy that names a new wife, and another one that names an ex-spouse as required by a court-ordered alimony or child support responsibility. We have heard from clients who listed a sibling, or even a girlfriend or boyfriend on a policy and excluded the spouse or listed the spouse as the Contingent or Secondary Beneficiary. The latter means they’re second in line to receive the insurance payout only if the Primary Beneficiary were to pre-decease the insured. These are all tricky scenarios that we steer clear of and defer to the policyholder’s wishes.
Simply put, the following states consider that both spouses have shared and equal rights to all assets earned during their marriage. If the couple’s money was used to buy property, it will be split 50/50. The benefit from a life insurance policy would also be included under these privileges and distribute the surviving spouse half of the insurance money, divided equally with any named beneficiary. The only exception to this would be if the spouse agreed to sign a form waiving rights to the money. (Good luck with that). If you live in one of the following states of the union that offer these special community property rights under State law you should discuss this with your tax advisor or accountant:
It is worth explaining that your life insurance beneficiary designation is important for more reasons than showing love. If you want your loved ones to benefit from the financial legacy you leave them, don’t squander the proceeds by making it taxable. Financial experts will advise you to keep it out of the probate process and name your heirs directly in the policy because life insurance proceeds receive federal income-tax free benefits when paid to a person.
It is not recommended that you name a minor child as a life insurance beneficiary because insurers will not pay them directly. Unless you have a trust with a named legal guardian, transferring that life insurance payout to the kids until they turn 18 or 21 (varies by state), the court will appoint one and that is not ideal. The child’s parent or another responsible adult would be a better life insurance beneficiary choice. Depending on the structure of a trust, the insurance money could be considered part of the deceased’s estate and treated as taxable income. Financial advisers will caution you not to name an insurance policy as “payable to my estate” as the beneficiary.
If you wish to know more about life insurance beneficiary rules, give us a call at 1-800-521-7873. Our professionals will be very happy to help you out.