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Wednesday, November 29, 2023

4 Common Mistakes Made on Life Insurance Beneficiary Designations


Investing in life insurance is a foundational part of estate planning, and when done right it’s a primary way to say “I love you” to your loved ones after you are gone.

The following mistakes are among the most common we see clients make when selecting life insurance beneficiaries. If you’ve made any of these errors, contact us immediately, so we can support you to provide the maximum benefit for those you love most.

  1. Failing To Name A Beneficiary

Far too many people fail to name any beneficiary on their life insurance policies, forcing insurance proceeds to go through the court process known as probate. During probate, a judge will determine who gets your insurance proceeds. This process can tie the benefits up in court for months or even years. Moreover, probate opens up the proceeds to creditors, which can deplete or even wipe out the funds.

We often recommend that the primary beneficiary of your life insurance is the Trustee of a well-considered Trust Agreement to provide maximum benefit and protection for your heirs.

  • Forgetting To Update Beneficiaries

Not keeping your beneficiary designations up to date can be even worse, especially if you are in a second (or more) marriage and fail to remove an ex-spouse as beneficiary, which can leave your current spouse with nothing when you die.

To prevent this, you should review your beneficiary designations annually as part of an overall review of your estate plan and immediately update your beneficiaries upon events like marriage, divorce, deaths, and births.

  • Naming A Minor (Or Their Guardian) As Beneficiary

You are technically permitted to name a minor child as a beneficiary of your life insurance, but it’s never a good idea as they cannot receive it until they reach eighteen in New York State. In the event a minor is listed, the proceeds of your insurance will be distributed to a court-appointed custodian, who will manage the funds (often for a not insignificant fee) until the child reaches the age of maturity. At that point, all benefits are distributed to the beneficiary entirely outright and unprotected.

This is true even if the minor has a living parent. A child’s living parent could petition to the court to be appointed custodian. Still, there is no guarantee that a parent would be appointed, especially if the parent cannot qualify or pay for a bond. A court could deem a parent unsuitable (if they have poor credit, for example) and instead appoint a paid fiduciary to control the funds.

Naming the person you have chosen as guardian of your child isn’t the right answer either. In that case, insurance would pay outright to the named guardian and could be used in any way they choose, or even be at risk of being taken in a divorce or by a creditor of the guardian.

Instead, the right answer is to set up a trust to receive the proceeds and name a trustee to hold and distribute the funds to the minor child when and how you determine.

  • Naming An Individual With Special Needs As Beneficiary

Although a loved one with special needs is likely one of the first people you’d consider naming as beneficiary of your life insurance policy, doing so can have tragic consequences. Leaving insurance directly could disqualify that individual from receiving much-needed government benefits.

Instead, you should create a “special needs trust” to receive the insurance proceeds. This way, the money won’t go directly to the beneficiary but would be managed by a trustee you name and dispersed without affecting benefit eligibility.

The rules governing special needs trusts are complicated, so meet with us today to discuss your options. In the end, special needs planning involves much more than just life insurance—it’s about providing a lifetime of care and protection.

While naming life insurance beneficiaries might seem simple, if you’re not careful, you can create major problems for the loved ones you’re doing your best to benefit. Meet with us today to ensure you’ve done everything properly.

This material was created for educational and informational purposes only and is not intended as tax, legal, or investment advice.

Nicole Palermo
Nicole Palermo
Founder and Principal Attorney of The Palermo Firm