Beneficiary mistakes are common when life insurance planning. Clients often name their child, a minor, as primary or contingent beneficiaries—after all, these are the individuals they most seek to protect.
However, death benefits will not be paid directly to minors. If the insured dies before a named beneficiary reaches the age of majority, the result may be substantial delays in loss settlement—even the possibility of an additional expense for the beneficiary.
Naming an estate as beneficiary is another common mistake. Some believe naming an estate as beneficiary ensures an equal distribution of life insurance death proceeds fairly dispersed by an executor.
But, when the beneficiary is an estate, the advantages of expedited tax-free benefits are lost. Instead, proceeds paid to the estate are included in the gross value of the estate for estate tax purposes. Plus, dispersal of funds to heirs will be delayed by the probate process.
3. Creating a Goodman Triangle
Named after the 1946 court cast Goodman v. Commissioner of the IRS, the Goodman Triangle occurs when the policy owner, the insured, and the beneficiary are three distinct individuals. If all three on the policy are different, the life insurance benefit is considered a taxable gift from the owner to the beneficiary.
In the Goodman case, Mrs. Goodman consolidated five policies on her husband's life into a revocable life insurance trust. She named the beneficiaries of the trust her three children and sister-in-law. When her husband died, the death benefits were eventually ruled as a gift to the trust beneficiaries due to this three-party scenario.
The Goodman Triangle can result in an unexpected gift tax liability, but only if a person owns another's life insurance policy names a third party (who is not the owner's spouse) as the policy beneficiary.
4. Failing to Regularly Review Life Insurance Needs
The purchase of life insurance is not a “one-and-done" event. Life can change quickly, and many clients fail to consider whether their policies are up-to-date.
Annual reviews can help clients ensure their policies remain reflective of their life and life insurance goals. You and your practice also become an important professional resource to your clients through these regular reviews—a consistent safeguard in life’s uncertainty.
5. Failing to Understand How Policy Loans Work
Policy loans are among the most popular benefits of permanent life insurance. The ability to take a loan from a policy can provide the policy owner with a source of funding when needed with no timeline for repayment.
However, some clients fail to understand that policy loans aren’t free. Ensuring your clients fully understand the potential financial impacts of a policy loan is important.
Policy loans do accrue interest and, if not paid back, can eventually cause the policy to lapse. If the policy remains active, outstanding loan payments also impact the amount paid for death benefits—potentially risking the financial security of the beneficiary.
Helping Prepare Your Clients
Life insurance planning mistakes can have significant consequences. Clients and beneficiaries could suffer coverage loss or tax liability. Insurance producers could lead to loss of client confidence or, in some cases, E&O claims.
The most common mistakes, like those listed above, are important to keep in mind as you regularly meet with and educate your client. The more you know about these and other common missteps, mistakes, or misunderstandings, the better equipped you’ll be to educate your clients and help them avoid any unintended consequences of their personal life insurance planning decisions.
WebCE’s continuing education courses are designed to help you attain your professional goals. Our insurance CE course Personal Life Insurance Planning: Mistakes to Avoid provides additional information on these, and many other, common planning mistakes.