Key features and benefits of a contingent beneficiary

If you need to learn what contingent beneficiary is in the context of life insurance, IRA, trust, or 401(k) plan, then this article is for you. We will also discuss its role in estate and trust laws and explain the difference between a primary and a contingent beneficiary.

What is a contingent beneficiary?

A contingent beneficiary means a person or entity designated as a backup or next-in-line to receive the proceeds of your life insurance policy or retirement account where the primary beneficiary is unable to obtain such funds. A primary beneficiary may be unable to claim the benefits of the insurance policy or living trust if he is missing, forfeit his interest in the policy, or for a number of other reasons.

Note! A secondary beneficiary is what is also known as a contingent one.

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Conditions for appointing as a contingent beneficiary

So, let’s figure out what the requirement to name a contingent beneficiary is on the incapacitation of the primary one. A few conditions must be fulfilled due appointment of a beneficiary.

1. Proceeds can pass if the account holder is deceased and the primary beneficiary is also deceased or declines the inheritance.
2. Other conditions for the contingent beneficiary to receive the proceeds can be set by the policyholder or testator. 
3. If there is more than one primary beneficiary, the proceeds will automatically pass to other primary beneficiaries until the list is exhausted.

Note! A contingent beneficiary can only be appointed by a legal instrument, i.e., named in the insurance policy, will, living trust, etc. It cannot be done orally.

How to appoint a contingent beneficiary

If you ask, “What is a contingent beneficiary designation?” or “What terms mean his appointing?” let’s move on.

Once the choice of the contingent beneficiary has been finalized, you may proceed to appoint appropriately. There are different ways to nominate a secondary or contingent beneficiary. The steps include:

1. Submit the name(s) of the contingent beneficiary for the 401(k) account to the administrator or insurance policy issuer when purchasing the policy. If it is a will, the beneficiary’s name and specific inheritance must be included in the provisions. Update it when there are changes, e.g., the death or mental disability of the primary beneficiary.
2. Specify the conditions for the contingent beneficiary to receive the proceeds. Usually, the conditions that apply to the primary beneficiary would apply to the contingent one. For instance, it could be for the beneficiary to move to a particular area or house, complete a professional course, or perform certain rites. Failure to fulfill the conditions would lead to the forfeiture of the proceeds.
3. Determine and state the percentage or benefits for each contingent beneficiary if there are multiple ones.

Note! It is recommended that you contact a qualified notary to execute the documents properly.

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What is a primary beneficiary vs. a contingent one?

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People often ask, “What is the difference between a primary and contingent beneficiary?”. The only similarity between a primary and contingent beneficiary is that they are both “heirs-in-line” and derive the benefits from the estate of the account or policyholder.

A primary beneficiary is the first in line to receive the benefits in a life insurance policy, will, or retirement account. The contingent beneficiary is the next after the rights of the primary beneficiary, i.e., in the case where the primary beneficiary cannot accept the benefits.

For example, Rose, a 67-year-old retired teacher with an individual retirement account (IRA), may select her only son in active military service, Tony, as the primary beneficiary of the account. She also appoints Hughes, her grandchild, as the primary beneficiary of her life insurance policy. If she so desires, what is next is that she may then designate Hughes as a contingent beneficiary to the IRA and Marylyn, her sister, as a contingent life insurance beneficiary to the insurance policy. 

If Rose passes away and Tony renounces his inheritance for any reason, Hughes will immediately become entitled to the IRA benefits. Or, if Hughes declines to accept the insurance policy’s proceeds, Marylyn will become entitled to it. 

Who should be your contingent beneficiary?

An individual to be appointed to be what is called a life insurance contingent beneficiary must be of legal age, or if a minor, must have a legal guardian appointed. Ideally, your contingent beneficiary should either be a relative, e.g., a spouse. In other instances, it can be a charity or trust organization.

Why should you appoint a contingent beneficiary?

There are many advantages to having a contingent beneficiary. Some of them include the following:

• Probate avoidance: Benefits or assets passed to contingent beneficiaries are not subject to estate administration procedures or taxes.
• Pre-determination of succession line: When you appoint a primary and contingent beneficiary, you can predetermine who gets your death benefits ahead such that if the primary beneficiary cannot accept the benefits, the contingent one would at least be able to receive the same. 
• Reducing conflict: By creating a clear line of succession, there are very minimal chances of conflict over that subject matter between your relatives. Everyone is clear on who comes next.

Despite all the above, you are free to decide how many beneficiaries to choose and whether to appoint them at all.

What happens if I don’t have a contingent beneficiary?

A contingent beneficiary designation is not mandatory. Where you fail to appoint a contingent beneficiary and your primary beneficiary is deceased, unavailable, or declines the benefits, the proceeds will form part of your residuary estate.

The implications are that the proceeds will pass to your relatives based on the residuary provisions in your will or administration of estate laws in your state. It also means that it will be subject to probate procedures and taxes. Worse still, it can be claimed by the estate’s creditors.

The bottom line

Contingent beneficiaries are an alternative to primary ones. They do not become entitled to the proceeds until the primary beneficiary is declared dead or unable to accept the benefits of a trust, IRA, or life insurance policy. Appointing one or more contingent beneficiaries will prevent the assets from going through probate procedures and being subject to taxes.