The parties involved in a life insurance policy are (1) the insurance company, (2) the policy owner, (3) the insured individual, and (4) the beneficiary and contingent beneficiary.
Your beneficiary is the person who gets the money after the angels carry you away. For a policy to be issued, you must name a beneficiary. You should also name a contingent beneficiary.
What’s a contingent beneficiary, and why do you need one?
A contingent beneficiary is a “just in case beneficiary”—“What’s the plan just in case the primary beneficiary isn’t around to bag the booty?”
As a Bank On Yourself Authorized Advisor, when I’m helping a family design a Bank On Yourself-type life insurance plan for the primary wage earner, I ask, “Who do you want your plan to protect?”
Invariably, the breadwinner will say, “My spouse.”
I then ask, “Who should get the money if your spouse doesn’t?” When they look at each other with puzzled expressions, I follow up with, “What if you both die in the same plane crash? Who gets the money then?”
That’s why you need a contingent beneficiary.
Naming a Contingent Beneficiary Is Critical!
Naming a contingent beneficiary on your life insurance policies may be even more critical than naming one for your 401(k), IRA, or investment account, because the life insurance proceeds can be significantly greater than what you’ve saved in your retirement accounts.
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Contingent beneficiaries you should not name:
Sometimes Mom and Dad want to name their children as contingent beneficiaries. But if the kiddos are minors, they’re not eligible under state law to receive your life insurance money. If a minor receives insurance proceeds as a beneficiary or contingent beneficiary, the court will appoint a legal guardian to oversee the money until the child reaches legal age.
Keep that in mind when you’re writing or updating your will. Work out an arrangement with someone you trust who is willing to be the guardian of your minor children in case both parents are gone.
Often this can be a reciprocal arrangement—“We’ll take yours if something happens to you, and you take ours if something happens to us.” Without a provision in your will, the court will use its great wisdom to pick a guardian. More about the court’s wisdom—or lack thereof—in a moment.
Can you name your cat as the contingent beneficiary of your life insurance policy? Yes, but don’t. It won’t hold up in court. Pets, like minors, don’t have legal standing to accept assigned assets. I don’t care how smart Whiskers is, he’ll never get the hang of endorsing a check.
The court will have to assign a guardian, who, expecting to be paid for his or her services, may end up receiving most of what you wanted to leave to your cat.
So What Else Can Go Wrong When Naming a Beneficiary or Contingent Beneficiary?
Consider the true story of Warren Hillman. In 1996 Warren names his wife, the lovely Judy, as the beneficiary of his life insurance policy.
So far, so good. But two years later it’s Splitsville for Warren and Judy. And four years after that, Warren and Jackie are the happy newlyweds.
Six years after that, Warren dies.
So, who gets the proceeds from Warren’s life insurance policy?
Jackie figures she should, as Warren’s lawfully wedded wife.
Judy, the ex, figures she should, as specified in the insurance policy—which has never been updated in more than 10 years.
For five years Judy and Jackie wrangle. Eventually, believe it or not, the case goes all the way to the U.S. Supreme Court.
And in 2013, by a unanimous 9-0 decision, the court rules that … drum roll, please … Judy—the ex-wife—is entitled to the proceeds from her former husband’s life insurance policy.
Part of the Court’s reasoning is that if Warren had wanted to change beneficiaries, he could have, simply by sending a note to the insurance company.
Jackie, Warren’s wife when he died, doesn’t get a penny.
We know life isn’t fair. Turns out death isn’t fair, either.
Don’t Put Your Contingent Beneficiary Out of Your Mind
The moral is, think. When your life changes, ask yourself what else needs to change? Maybe your insurance policy. Think how much grief and money Warren could have saved his two beloveds if he had talked with his insurance advisor after he talked with his divorce attorney.
For most people, choosing a contingent beneficiary is more difficult than choosing a beneficiary. There are more “what if’s?” to think about. For example:
Let’s say you have three grown sons, Arnie, Barney, and Charlie. Each has given you two grandchildren. You name your spouse as the beneficiary of your life insurance policy, and you name Arnie, Barney, and Charlie as contingent beneficiaries, with the money to be divided equally between them.
Then there’s a horrible ballooning mishap involving you, your spouse, and Arnie. Arnie is killed instantly in the carnage. You and your spouse eventually die from your injuries. Who gets the life insurance money?
Depending on how your beneficiary statement is worded, the money could be divided equally between Barney and Charlie. Arnie’s two kids—your favorite grandchildren, truth be told—would get nothing. After all, by the time you died from your injuries, Arnie had already died. Legally, he was out of the picture.
Or, Arnie’s two kids could divide his one-third, and Barney and Charlie would each get one-third.
Or, Arnie’s two kids and Barney and Charlie could each get one-fourth.
When it comes to your life insurance policy’s contingent beneficiaries, spell out your wishes very carefully!
Some judge is going tell your heirs what you meant, unless you make your wishes known in your life insurance policy’s list of primary beneficiaries and contingent beneficiaries.
The insurance company charges you nothing to change your list. To help with the process, work with a life insurance professional who will periodically ask you, among other questions, “Who has gotten married or divorced? Who has died or been born?”
A good advisor will ask you, and will help you update your life insurance policies accordingly.
Check out our helpful No-Nonsense Guide to Life Insurance now, for other life insurance topics you had no idea were so important.