When it comes to life insurance, there are three distinct roles that come into play:
- the policyowner,
- the insured,
- and the beneficiary.
A life insurance policy covers one person, called “the insured” in insurance paperwork. The policy’s owner is the person who purchases the coverage on the insured. The beneficiary is the person who receives the benefit amount when the insured dies. In this post we’re going to focus on the role of policyowner, and help you understand what it means to be the owner of a life insurance policy.
» Calculate: Life insurance needs calculator
Who can own a life insurance policy?
Any person (an adult, not a minor) or legal entity can own life insurance on another person as long as there is insurable interest and mutual consent.
Insurable Interest: Insurable interest exists when the death of one person would negatively financially affect another person.
The most common example of insurable interest is a spousal relationship. If one spouse died, the surviving spouse would likely have trouble continuing to maintain his/her same standard of living (paying the mortgage, raising children, etc.) on one income.
Here are some common policyowner and insured scenarios:
- Husband owning a life insurance policy on wife (and vice versa)
- Parent owning a life insurance policy on child
- Business owning a life insurance policy on a key employee
- Business co-owner owning a life insurance policy on fellow co-owner
- You owning life insurance on yourself
Maintaining life insurance policy ownership also means you have the responsibility to occasionally review the policy to ensure it is up-to-date and still structured to be of most benefit to you and the beneficiaries.
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What does it mean to be a policyowner of life insurance?
Life insurance policy ownership means you have all the control and responsibility of the policy.
Being the owner of a life insurance policy means:
When should policyowners review their policies?
Here are four common life events in which it is recommended to review your life insurance policy:
Marriage or Divorce
You would be surprised at how often someone with life insurance dies and ends up leaving their spouse with nothing because their ex-spouse is still listed as their primary beneficiary.
If the policyowner forgets to update his policy to reflect the needed change of beneficiary, there is nothing the should-have-been-beneficiary can do about it.
If you purchased life insurance before having children and only purchased enough to cover the mortgage, but not the costs of raising a child or college tuition, it might be time to consider purchasing more coverage.
Don’t forget to add any new children to your policy as well. However, if you name your children as beneficiaries and die before they reach legal age the court will appoint a guardian to handle the proceeds until the child reaches 18 or 21, depending on the state. This is a costly and inconvenient process which is why we don’t recommend listing young children as beneficiaries.
» Learn more: Naming Minors as Beneficiaries: UTMA and UGMA
Instead, you should set up a trust to benefit the child and name the trust as the beneficiary of the policy, or name an adult custodian for the life insurance proceeds under the Uniform Transfers to Minor Act (UTMA).
John Smith and ex-wife Jane have a 10-year-old child together named Lola. When he bought his life insurance policy, John set it up so that 100% of his death benefit would go to his former wife Jane, as custodian of his minor child Lola.
John then remarried, and he and his current wife Nancy ended up having a baby named George. John updates his policy to state 50% of his death benefit going to Jane, as custodian of Lola, and 50% of his death benefit going to Nancy, as custodian of George.
It would likely not have been a pleasant outcome if John passed away and forgot to update his policy to include his new child.
Selling the bachelor pad and buying a house for your growing family? You may need more life insurance coverage. Buying a vacation home in Florida for the family that you want to make sure stays in the family? You may need to purchase more coverage so that the death benefit includes the extra mortgage payments.
It’s a nice bonus if your employer offers a group life insurance plan, but when you change jobs, your plan doesn’t follow. It’s always a good idea to review your financial portfolio when you get a new job. Not all employers offer life insurance so if you have a family we recommend you buying an individual life insurance policy as well so you can always be sure you’re covered.
» Learn more: Do I Need Individual Life Insurance if I Have Group Life Insurance?
If you get a promotion that increases your monthly income substantially, will your family’s lifestyle change? This new salary may mean new cars, private school for the kids, or maybe a bigger home. You may need to increase your coverage to protect your family’s new standard of living.
Should I own my life insurance policy?
It’s quite common for an individual to be both the policyowner and the insured. Being both the policyowner and the insured keeps things pretty simple. Your life is strictly in your hands. There are certain situations though in which this isn’t the best route.
If you own your own policy, the proceeds become part of your federal taxable estate if your estate exceeds the exclusion amount. The