A life insurance application comes with numerous questions and involves making certain decisions. One important aspect is deciding who you will designate as your beneficiary and whether they will be revocable or irrevocable.
A revocable beneficiary is a beneficiary who can be changed at the policyholder’s discretion, while an irrevocable beneficiary is a beneficiary who cannot be changed without written permission from the beneficiary.
You might be curious about the differences between these two options. Why would someone opt for an irrevocable beneficiary, and what are the merits and drawbacks of this choice?
In this blog post, we will enlighten and guide you into choosing between revocable vs irrevocable beneficiary, providing you with the knowledge needed for a smooth insurance application.
What Is A Life Insurance Beneficiary?
A life insurance beneficiary is the individual or entity chosen to receive the death benefit payout from a life insurance policy. Regardless of the specific insurance policy you’re applying for, designating a beneficiary is a crucial step.
In Canada, it’s quite common to name a spouse or child as a beneficiary. They are the ones who will ultimately receive the death benefit as a tax-free lump sum, which can be used for various purposes like paying off debts, covering estate taxes, handling funeral expenses, or meeting day-to-day living costs. The primary objective is to ensure that your family and loved ones remain financially secure in the event of your passing.
You also have the option to name a minor as a beneficiary, although in such cases, a trustee will be responsible for managing the funds until the minor reaches the legal age of majority and can handle the money on their own.
In a charitable or philanthropic gesture, you can designate a charitable organization as your beneficiary, leaving a lasting legacy of goodwill. Alternatively, if you’re a business owner, you can select your business as the beneficiary to safeguard its continuity in the event of your demise.
Beneficiaries can fall into one of two categories: revocable and irrevocable. By default, most life insurance policies designate beneficiaries as revocable. However, there are valid reasons why you might choose to designate an irrevocable beneficiary.
What Is Revocable Beneficiary?
A revocable beneficiary is someone the policyholder can change or remove as the beneficiary at any time without their approval. This type of beneficiary designation gives the policyholder flexibility and control over who will receive the death benefit payout from the life insurance policy.
If all the beneficiaries listed on your life insurance policy are revocable, you can make changes to your policy without seeking anyone’s permission.
For instance, let’s say you have two children, Jane and Joyce, and you’ve chosen both to receive 50% of your death benefits. In this case, both Jane and Joyce are designated as revocable beneficiaries.
As time goes by, if Jane is the one who frequently visits and takes care of you while Joyce doesn’t, you can decide to adjust your death benefit distribution to give Jane 75%. If both children were designated as irrevocable beneficiaries, Joyce might resist this change and withhold her consent.
What Is An Irrevocable Beneficiary?
An irrevocable beneficiary is someone whose status as the beneficiary cannot be changed or revoked without their explicit consent.
This designation firmly secures the chosen beneficiary, preventing the policyholder from making alterations without the beneficiary’s agreement. Importantly, in the event of the policyholder’s passing, irrevocable beneficiaries take precedence over revocable ones.
In most Canadian provinces, beneficiary designations are naturally revocable unless explicitly specified otherwise when filling out the necessary forms. However, in Quebec, if an individual designates their spouse as the beneficiary, it is automatically considered irrevocable unless the policyholder specifically allows for it to be revoked when initially naming their spouse as the beneficiary.
What is the Difference Between Revocable and Irrevocable Beneficiary?
The main contrast between revocable and irrevocable beneficiary designations in an insurance policy lies in their flexibility. Revocable beneficiaries can be altered or removed by the policyholder at any time. Conversely, irrevocable beneficiaries cannot be changed or cancelled without the explicit consent of the beneficiary.
These are just a few examples of when choosing an irrevocable beneficiary can be advantageous. Let’s explore some common scenarios where choosing an irrevocable beneficiary makes sense:
- Court-Ordered Divorce Settlement: In the event of a divorce with children, child support, or alimony obligations, the court might require one spouse to obtain life insurance and designate their ex-spouse as an irrevocable beneficiary. This ensures that the death benefit goes towards the specified purposes, such as child support or education expenses. The policyholder can’t change this designation without their ex-spouse’s consent, preventing any attempts to evade financial responsibilities.
- Loan Collateral: If you intend to use a life insurance policy as collateral for a loan, you must name the lender as an irrevocable beneficiary. This arrangement guarantees that the lender will receive the policy’s death benefit if you pass away. In exchange for this designation, the lender may provide you with financial assistance during your lifetime. Once you repay the loan, the lender will remove themselves as the beneficiary, allowing you to designate a different beneficiary.
- Creditor Protection and Peace of Mind: Designating an irrevocable beneficiary ensures that a specific person or entity will receive the death benefit, regardless of unforeseen circumstances. Knowing that your loved ones and dependents are safeguarded from potential creditors’ claims provides peace of mind.
- Tax Planning: Some estate or tax planning objectives can only be achieved by naming an irrevocable beneficiary. For instance, this strategy may be used in connection with charitable giving, helping you optimize your tax liabilities.
Benefits and Drawbacks of Irrevocable Beneficiaries
There are several advantages and disadvantages to naming an irrevocable beneficiary:
Pros
- The death benefit payout from the life insurance policy will go directly to the chosen beneficiary, bypassing any potential probate proceedings.
- The policyholder cannot change or remove the designated beneficiary without the beneficiary’s consent.
- The named irrevocable beneficiary has priority over every other beneficiary in case of the policy owner’s death.
Cons
- If the policyholder changes their mind about wanting to leave money to a specific individual or organization, they cannot do so without getting consent from the named beneficiary.
- If the policyholder dies while the designation is still in effect, the proceeds from the insurance policy will go directly to the named beneficiary, regardless of their will. So, if someone names their spouse as an irrevocable beneficiary but then divorces them, their spouse would still inherit any proceeds from the insurance policy.
- If something happens to the named beneficiary, it may be more difficult for whomever they choose as their contingent beneficiaries to claim inheritance rights.
How To Change Or Remove An Irrevocable Beneficiary Designation
Changing or removing an irrevocable beneficiary can be a challenging task due to its inherent permanency. An irrevocable beneficiary can only be altered or removed if the beneficiary willingly agrees to relinquish their status.
To make changes or remove an irrevocable beneficiary designation, the policyholder must obtain written consent from the beneficiary. In the case of a minor beneficiary, the policyholder must also secure written consent from the minor’s parent or legal guardian.
However, in situations where there is no designated beneficiary, the death benefit from the life insurance policy will be directed to the policyholder’s estate. This, in turn, can trigger probate proceedings, which are not only time-consuming but also potentially costly.
Revocable Vs Irrevocable Beneficiary: Things to Consider When Making a Decision
The decision between revocable and irrevocable beneficiary designations comes down to a trade-off between “control” and “permanence.” An irrevocable beneficiary enjoys a level of permanence, meaning they take precedence over other beneficiaries upon your passing.
However, I firmly believe that, in most cases, it’s wise to designate primary and contingent beneficiaries as revocable. This choice grants you greater control over your life insurance policy and simplifies any adjustments should your circumstances or priorities change.
Beneficiary designations should remain non-permanent unless mandated by a court or if you intend to use your policy as loan collateral.
While selecting an irrevocable beneficiary might seem appealing initially, it’s crucial to acknowledge that relationships can deteriorate, and even strong marriages may end in divorce. Hence, it’s often preferable to have a beneficiary designation that you can modify without the complexities of seeking consent from one or multiple (potentially disgruntled) parties.
Final Thoughts on Revocable Vs Irrevocable Beneficiary
When it comes to choosing between a revocable and irrevocable beneficiary for your life insurance policy, the key lies in finding the right balance between control and permanence. Remember, opting for revocable beneficiaries can provide the flexibility you need, ensuring your insurance policy aligns with your changing circumstances.
Please contact us if you have any more questions or need further guidance on your life insurance policy. We’re here to help you make the right choice and provide you with the peace of mind you deserve.
