How to Choose Your Life Insurance Beneficiaries

This decision is an important one for protecting your family's finances.

Life insurance policies protect beneficiaries. When a life insurance policy is purchased, it pays out a death benefit if the person covered by the policy dies while the policy is in effect. A death benefit won't be useful to someone who has passed away, but the policyholder chooses beneficiaries who will receive this money from the insurance company after their death.

That's why picking the right beneficiaries is so important.

But, how can a person buying life insurance choose the right people to receive the death benefit? Here are a few key things to consider when making this crucial decision.

Who will need the financial help?

Life insurance is purchased to provide a death benefit to people who are currently reliant on the deceased to provide income or services. As a result, it makes sense to leave money to beneficiaries who would need the money from the death benefit to maintain their standard of living after the policyholder passes.

Often, spouses and children are appropriate beneficiaries. If the policyholder's spouse would be left unable to pay the mortgage if the policyholder died, the surviving spouse would make a good beneficiary because they'd have a strong financial need. The same is true if the policyholder's children wouldn't be able to afford the cost of education.

Others could also be beneficiaries as well. This could include aging parents reliant on the policyholder for caregiving services they'd have to pay for if the policyholder passed. Or it could include a business partner who would need money to buy out the interest of the deceased policyholder.

What are the rules for beneficiaries?

It's also important to know what rules, if any, could apply to the individuals who might be named as beneficiaries.

For example, in some community property states, a surviving spouse may have a legal claim to part of a life insurance death benefit -- even if someone else has been named as a beneficiary. And if a child is named as beneficiary, the child can't inherit and manage the money directly if they are under 18, so parents may need to set up a trust or appoint a guardian.

Does a beneficiary have to be a person?

Policyholders shouldn't assume they must name a person to be the beneficiary. In some cases, a trust could be a better option than an individual.

Naming a trust as a beneficiary could be the best move in situations where the money is meant to benefit a minor or disabled dependent who couldn't manage the cash themselves.

If the policyholder wants to ensure the death benefit is used for something very specific, such as paying for a child's education, then they could also create a trust that sets limits on the use of the money. A trust could also help to ensure that the money doesn't fall into the wrong hands in the event of a beneficiary's divorce or if the beneficiary isn't very responsible with money.

Would multiple beneficiaries make sense?

Finally, policyholders should consider whether it makes sense to name multiple people as beneficiaries. This could involve naming a spouse and several children each as beneficiaries, or naming a spouse as well as aging parents.

Ultimately, each person buying life insurance should think about the best way to protect and provide for the people they care about and should select their beneficiaries accordingly.