Whether you’re taking a contract for your business or personally, naming a beneficiary is a valuable feature of life insurance and segregated funds policies so it is important to carefully choose your beneficiaries. Have you made any of these common mistakes with your beneficiary designation?
Estate – the default choice
Many people choose to name their “estate” as their beneficiary. Although this is an easy short-term solution, it is important to review the risks of doing this. If you are stuck for a significant “other” beneficiary, don’t forget to change it to a more appropriate option later. Why?
- The proceeds will be subjected to probate fees and the benefits received will be co-mingled with all the other estate assets which may be exposed to various third parties.
Most Common Mistakes Made with Corporately Owned Life Insurance Beneficiaries
- a beneficiary designation other than the corporation such as a spouse, child or other individual, will result in it being a taxable benefit to the recipient. If the corporate policy is for a buy-sell arrangement for shareholders or keyperson insurance, the corporation should be designated as the beneficiary, and by utilizing the Capital Dividend Account (CDA) and a Letter of Direction, the money will flow into the desired hands of the shareholder or his/her estate upon his/her death tax free.
- corporately owned life insurance is not considered a business expense because the beneficiary is the corporation. Corporately owned life, Critical Illness on the life of a shareholder gets paid through retained earnings (after corporate tax is paid) and not considered a business operating expense. The only exception is when life insurance is securing a third party loan, such as a bank, and the lending institution is the designated beneficiary.
What’s in a name?
Simply naming an individual or trust as beneficiary will keep the proceeds out of the insured’s estate and also protect the death benefit from the claims of creditors or litigants.
VIP Beneficiary Designation
A “preferred beneficiary” is a spouse, parent, child or grandchild and receives VIP treatment in the form of protection. All the proceeds of the life insurance product (including Segregated Funds) are protected against claims of the creditors or litigants of the life insured not only upon his or her death, but any cash values in that policy are also protected during the lifetime of the insured.
- A minor “preferred beneficiary” will require a trustee for their portion until they reach the age of majority.
- Note that the preferred beneficiary status does not apply to siblings.
Trust your trustee
Think carefully about to whom you assign the task of trustee. It can be a difficult role to fill, often challenged by trying relationships. Be sure to discuss the role with your intended trustee and make sure they are comfortable with it and understand the responsibilities of the role.
Often parents of minor children are concerned about what would happen should they both tragically pass away at the same time. For this reason, the children are often named as “contingent beneficiaries”. If the children are minors, the trustee named to act on their behalf will receive the proceeds directly upon the death of their parents avoiding any estate considerations.
As life changes, so should your beneficiary designation
If you have an older life insurance policy it is probably a good idea to review the named beneficiary as your circumstances may have changed.
It may be time for a change if……
- You have divorced – if you have a divorce agreement that required you to maintain your spouse as the beneficiary, have the conditions of that requirement now expired (e.g. children are now of age) and is no longer required?
- If you have remarried – is your ex-spouse still named as the beneficiary?
- If a policy was assigned to the bank or other lending institution – have the assignment removed if the loan is paid off.
- If you have new dependents – children, grandchildren or even dependent parents.
- If your children are now grown up – and have families of their own, does this change how you want your life insurance proceeds to be paid?
- If your children are married, their spouses may have access to these proceeds too. Is their relationship solid, or is there a risk of half of your life insurance proceeds being paid out as part of a divorce settlement? Perhaps you should consider naming your grandchildren as beneficiaries instead?
The need for life insurance no longer exists
Often, older individuals find they have no one to whom they wish to leave their insurance proceeds. In this situation, naming a registered charity will provide a charitable tax deduction in the full amount of the proceeds at death.
Let’s review your beneficiary designations and make sure your life insurance proceeds end up where you want them to be. As always, please feel free to share this article with anyone you think will find it of interest.
Chris Coulter is the Founder and President of The Finish Line Group. He works with business owners to leverage their businesses to increase their wealth, reduce corporate and personal taxes, create viable succession strategies, enable employee retention strategies and allow them to exit their businesses on their terms.
Chris’ passion for what he does evolved from the mistakes he made in his first business; by not diversifying his risk and not utilizing a lot of the opportunities within his business to create significant wealth. Chris found out the difficult way and now educates business owners on how to avoid many of his former oversights and ultimately control where their finish line ends.