Life Insurance

First, choose your beneficiary.

Choosing your beneficiary is the most critical decision you will make when you apply for term life insurance.

A close second and third are choosing the amount of coverage and term length. After all, you can do your homework and select the perfect amount of coverage, but if you leave it to the wrong person, what good is it?

With this in mind, let's make sure you get it right the first time, even though you will get another chance. More about this later. For now, though, these guidelines will set you on the right path.

What is a Life Insurance Beneficiary?

A beneficiary is a person or entity who will receive the death benefit from your policy if you die. The death benefit is also called the coverage amount or policy proceeds, but we'll stick with the death benefit to keep things simple.

The death benefit is usually paid by the life insurance company directly to the beneficiary. This money is generally not subject to income tax but may be subject to estate tax.

A Beneficiary Must Have an Insurable Interest

When life insurance companies review beneficiary designations on applications, they are looking to see an "insurable interest" between the insured person and the beneficiary. For life insurance purposes, a beneficiary has an insurable interest in the insured person when the person's loss would cause the beneficiary to suffer a financial loss.

Think about it regarding financial dependence. If someone is financially dependent upon you, that person is likely a reasonable choice for a beneficiary. The most apparent relationships are husbands/wives and parents/children, although there are many other options. There are also exceptions, such as charitable donations, which we'll look at more closely.

There are Three Beneficiary Categories

Let's look at the three categories of beneficiaries you'll need to consider for your policy.

• Primary: The primary beneficiary is the first in line to receive the policy death benefit. The most common arrangement is spouse/spouse. The first spouse is the insured person and the second spouse is the primary beneficiary.

• Contingent or Secondary: The contingent beneficiary is the second beneficiary in line to receive the policy death benefit. The life insurance company will pay the death benefit in the absence of a primary beneficiary, such as when the insured person and primary beneficiary die at the same time.

• Tertiary: Tertiary means of the third order. Therefore, the tertiary beneficiary is third in line to receive the policy death benefit. As with the contingent beneficiary, the tertiary beneficiary receiving the death benefit is contingent upon the absence of both a primary and a contingent beneficiary. It's not very common to name a tertiary beneficiary on a term life insurance policy. Most life insurance applications don't even include a tertiary beneficiary section.

You Can Have Multiple Beneficiaries.

So far, we've talked about a beneficiary in the singular form. But you can designate multiple beneficiaries of each type for your policy. For example, you can have two primary beneficiaries and three contingent beneficiaries. Or you can have five primary beneficiaries and no contingent beneficiaries. There are no limits to the number of beneficiaries you designate, as long as each one has an insurable interest.

When selecting multiple beneficiaries, you'll need to make sure the percentage split between all beneficiaries in a category totals up to 100 percent. If you designate one primary beneficiary to receive 50 percent of the death benefit, the remaining primary beneficiaries combined must receive the remaining 50 percent.

Here are some examples.

Here are two examples of splitting the death benefit among multiple beneficiaries.

Primary — Share

Spouse — 50%

Parent — 34%

 Charity — 20%

Total — 100%

Contingent — Share

Parent — 24%

Child 1 - 33%

Child 2 — 33%

Total — 100%

If you add multiple beneficiaries, you can also add a special designation to ensure the policy death benefit goes where you want it.

• Per Capita: This means if a beneficiary dies before the insured person, the remaining beneficiaries will receive the deceased beneficiary's share of the death benefit. This is the default distribution method on most current policies and how the life insurance company will handle the proceeds unless directed otherwise.

• For example, you name your parents as your primary beneficiaries. If one of your parents dies before or at the same time as you, the surviving parent will receive all death benefits.

• Per Stirpes: No, not a typo. Per stirpes means if a beneficiary dies before the insured person, that beneficiary's share will pass to her heirs and not to the remaining beneficiaries as with per capita.

• For example, you name your three brothers as your primary beneficiaries. If one of your brothers dies before you (or at the same time), his share will go to his survivors and not to your remaining two brothers.