What is a Beneficiary?

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Definition:

A beneficiary is a person who benefits, profits, or gains from something — in finance, typically an insurance policy, will, or trust fund established by a grantor.

🤔 Understanding beneficiaries

A beneficiary is a person who benefits from something. In the world of finance, you can be the beneficiary of many things. There isn’t always a single beneficiary. You can name multiple beneficiaries. For example, the heirs of a will each typically inherit a portion of the decedent’s estate. The beneficiaries of a trust fund benefit from the assets in the trust. The beneficiaries of a life insurance policy receive payment when the insured passes away. Typically, people establish beneficiaries for things like wills or insurance policies when writing those documents.

Example

Imagine Rebecca is the breadwinner for her family of three people. To provide for her family if she should pass away, she signs up for a life insurance policy that pays out three years of her annual income when she dies. In the life insurance documents, she names her husband as the beneficiary of the policy. If Rebecca passes away while the insurance is active, the insurance company will make the insurance payment to her husband.

Takeaway

A beneficiary is like the guest of honor at a party…

When someone plans a party for another person, they expect that person, the guest of honor, will enjoy the event. Other guests might bring them gifts, and the guest of honor will generally benefit from being in the spotlight. Similarly, the beneficiary of something like a trust or insurance policy will receive benefits from the people who established those policies or trusts and named them as beneficiary.

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What is a beneficiary?

At the most basic level, a beneficiary is any person who benefits from something. In the world of finance, beneficiary is a legal term that refers to the person who benefits from something like a trust, will, or insurance policy.

When someone establishes a trust fund, they name a trustee, who manages the trust’s assets, and a beneficiary for the fund. The trustee must manage the trust and distribute its money and assets to the beneficiary according to the trust’s rules. Even though they control the money in the trust fund, the trustee does not get the benefit of the trust’s assets. Instead, the beneficiary receives money from the fund.

When someone signs up for a life insurance policy, they need to name a beneficiary. Life insurance policies pay a death benefit when the insured passes away, so the insured won’t be using the money themselves. Instead, they must designate a relative, trust fund, or organization as the beneficiary. When they pass away, the insurance company pays the insurance benefit to the named person or group.

What are the types of beneficiaries?

When naming beneficiaries for a life insurance policy, trust, or something else, you can typically designate different types of beneficiaries.

Primary beneficiary

A primary beneficiary is a person you name to receive a benefit having priority over others. For example, if you purchase a life insurance policy, you might name your spouse as the primary beneficiary. Your spouse becomes the first person in line to receive the payout from the insurance company when you pass away.

When choosing beneficiaries, the primary beneficiary is the most important one. So long as the primary beneficiary is alive and legally competent, they can receive a benefit. If the primary recipient cannot accept the payment, either because they have also passed away or are lawfully incompetent, other beneficiary designations become essential.

You can name more than one primary beneficiary for a trust or insurance policy. If you do choose to designate more than one, you must indicate what each person should receive. For example, you might select two primary beneficiaries for a life insurance policy and specify that each should get an equal share of the death benefit.

Contingent beneficiary

A contingent beneficiary, sometimes called a secondary beneficiary, is like a backup to the primary beneficiary. If the primary beneficiary cannot receive the life insurance payment, the contingent beneficiary gets the benefit instead.

Naming a contingent beneficiary lets you prepare for unexpected events. For example, if you purchased a life insurance policy to cover living expenses for your family, you might want to name your spouse as the primary beneficiary. You could designate your eldest child as the contingent beneficiary. If both you and your spouse pass away in an accident, your insurance policy will pay to your child instead of your estate. This means that your child has the right to access the funds without the money going through a drawn-out probate process.

Contingent beneficiaries can also receive a benefit if the primary beneficiary cannot be located or refuses to accept the benefit for any reason.

Revocable beneficiary

When you name the beneficiary of a life insurance policy, you can choose to make them a revocable or irrevocable beneficiary.

If you name someone as a revocable beneficiary, you are free to change the beneficiary on your life insurance policy at any time. The beneficiary does not need to agree; you can remove them from the plan and name someone else in their place.

Revocable beneficiaries are common because people’s life situations regularly change. If you name a spouse and later get a divorce, you’ll most likely want to change the beneficiary to someone else. If they are revocable, you can also change the beneficiary for other reasons.

When it comes to trusts, you can establish revocable and irrevocable trusts. Setting up a revocable trust is similar to choosing a revocable beneficiary — it gives you the option to change the terms or the beneficiary at any time. Making a beneficiary revocable gives you more flexibility to make changes to your plans over time.

Irrevocable beneficiary

Irrevocable beneficiaries are the opposite of revocable beneficiaries. When you name someone as an irrevocable beneficiary of an insurance policy, you’ve committed. You cannot remove them from the list of beneficiaries or make other changes to the list. The only way to make a change to an irrevocable beneficiary is with their agreement.

Irrevocable beneficiaries are far less flexible than revocable ones. It can be hard to get an irrevocable beneficiary to agree to a change because they are giving up a financial benefit if they agree.

In the world of trusts, establishing an irrevocable trust causes the assets you contribute to the trust to immediately become the property of the beneficiary. You cannot take the money back or change the beneficiary of the trust without their agreement.

Who qualifies as a beneficiary?

You can name almost anyone or any organization as the beneficiary of a trust or insurance policy. You can name a spouse, child, friend, charity, trust fund, or your estate as the beneficiary.

Some states, known as community property states, won’t let you name a non-spouse as a beneficiary for life insurance without your spouse’s approval. In these states, all property owned by either spouse is considered joint property, so the value of your insurance policy legally belongs to your spouse. This restriction does not exist in non-community property states.

There are a few restrictions on a beneficiary’s ability to receive a benefit from a trust or insurance policy.

For example, if you name your child as the beneficiary of your insurance policy, they may run into problems if you pass away while they are still a minor. Insurance companies won’t pay the benefit to a minor. Instead, a court will have to name a guardian for the child’s insurance payout. This can be an expensive process, reducing the value of the insurance payout.

If the named beneficiary is legally incapable of receiving the benefit, it can also cause issues. This can happen if a doctor says the beneficiary is mentally incompetent.

How do you designate a beneficiary?

You typically designate a beneficiary when you sign up for a life insurance policy or establish a will or trust. The documents that you sign when signing up for insurance include a section where you name your beneficiary. Usually, you need to provide a name and identifying information, such as their relationship to you, address, or even Social Security number.

When you establish a will or trust, you name the beneficiary in the documents. Trust documents also outline the terms of the trust, restrictions on how the beneficiary can use its assets, and the trustee who will manage the trust.

If you’ve designated a revocable beneficiary, you can change or remove beneficiaries at any time. The process for changing beneficiaries will vary from one insurance company to another.

What is the role of a beneficiary?

The role of a beneficiary is receiving the benefit of a trust, will, or insurance policy. That means receiving payment from the insurance company or taking possession of assets left to them through a will or from a trust.

Beneficiaries may have some additional responsibilities based on the assets they receive. For example, the beneficiary has to handle any taxes that they owe based on what they receive. So, if a beneficiary receives real estate, they must pay real estate taxes.

Beneficiaries of trusts must meet the requirements set in the trust document if they want to receive money from the trust. For example, the grantor can establish a trust with the goal of funding the beneficiary’s education. To ensure the funds are properly used, they may require the beneficiary to attend college before accessing the funds.

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