Beneficiaries: the designation that overrides your will

Life insurance proceeds pass by beneficiary designation, not by will.

This is the most consequential and most neglected piece of paperwork in personal finance.

Why the designation controls

A life insurance policy is a contract. The insurer pays whoever is named as beneficiary.

A will governs assets passing through the estate. Insurance proceeds with a valid named beneficiary do not pass through the estate.

Which means a will leaving everything to your current spouse does not redirect a policy still naming a former one.

This situation occurs constantly. Policies taken out at a first job, or during a first marriage, and never updated.

Some states have statutes revoking former spouse designations on divorce, and their application varies and does not extend to all policy types — notably, federal law preempts state revocation statutes for many employer-sponsored plans.

Do not rely on a statute. Update the form.

Primary and contingent

Primary beneficiaries receive the proceeds. Multiple primaries can be named with percentages.

Contingent beneficiaries receive proceeds if no primary survives.

Naming a contingent is important. If the primary predeceases you and there is no contingent, proceeds generally go to the estate — which subjects them to probate, potentially to creditors, and to distribution under the will rather than as you intended.

The problems with common choices

Naming your estate. Generally avoid. Proceeds become subject to probate — public, slow, and reachable by creditors of the estate in most circumstances.

Naming individuals keeps proceeds outside probate and available quickly, which is frequently the point.

Naming a minor child directly. A significant practical problem.

Insurers generally cannot pay proceeds directly to a minor. A court-supervised guardianship or conservatorship is typically required, which is slow, costly, and gives the child full control at the age of majority.

The alternatives are naming a trust for the child's benefit, or using a custodial account arrangement under state law, both of which allow control over timing and use.

Naming a person who receives means-tested benefits. A lump sum can disqualify a disabled beneficiary from needs-based programs.

A special needs trust is the standard solution and requires proper drafting.

Naming a trust without checking the drafting. Trusts can be appropriate and must be named correctly, with the exact legal name and date.

Per stirpes and per capita

Terminology that determines what happens if a beneficiary predeceases you.

Per stirpes means a deceased beneficiary's share passes to their descendants. If you name three children equally and one predeceases you leaving two children, those grandchildren split their parent's third.

Per capita means the share is redistributed among the surviving named beneficiaries. The surviving two children take half each and the grandchildren receive nothing.

Most people, asked directly, want per stirpes. Most forms default to per capita unless specified.

State it explicitly on the form.

Community property considerations

In community property states, a spouse may have rights in policies purchased with community funds, and naming someone other than the spouse may require spousal consent.

Employer retirement plans have their own spousal consent requirements under federal law.

Check the rules that apply to you.

The review schedule

Review beneficiary designations after every one of these: marriage, divorce, a birth or adoption, a death of a named beneficiary, a significant change in a beneficiary's circumstances, and any change of employer.

The employer point matters. Group coverage changes when you change jobs, and the new designation must be completed. People frequently assume it carries over.

Otherwise, review every few years as a matter of routine.

Everything else with a designation

The same principle applies to a range of assets, and people update the insurance and forget the rest.

Retirement accounts. Employer pension and savings plans. Annuities. Transfer-on-death and payable-on-death accounts. Health savings accounts.

All pass by designation rather than by will.

Make a list of every account with a beneficiary designation and check each one. It is an afternoon and it prevents outcomes that cannot be corrected later.

Practical matters at claim time

Tell your beneficiaries the policy exists, which insurer holds it, and where the documents are.

Unclaimed life insurance proceeds are a genuine problem. Beneficiaries who do not know a policy exists do not file a claim.

There are state unclaimed property searches and industry locator services, and they are an imperfect remedy for a problem solved by a conversation.

Keep a document listing policies, insurers, policy numbers and contact details, and tell someone where it is.

General information about insurance and estate concepts, not legal, tax or insurance advice. Beneficiary rules, spousal rights and trust requirements vary by state and plan type. Consult a qualified attorney.