When you set up a life insurance policy or a retirement plan, the paperwork will likely ask you to name a beneficiary for the benefits. While setting up a beneficiary is a quick process, it's also an important one. But what is a beneficiary, exactly?

Here's some information to help you understand what a beneficiary is, why they're important and how to choose one.

What Is a Beneficiary?

A beneficiary is the person or entity set to receive your account benefits after you pass away. It's usually a person, but you could also name a charity, trust fund, business or other entity as a beneficiary.

What a beneficiary receives after you die depends on the type of account. With life insurance, the beneficiary would receive the death benefit from your policy. Your bank account, retirement plans and investment accounts may also ask you to name a beneficiary. Upon your passing, the financial institution would transfer the account balance to the beneficiary.

Why Do You Name a Beneficiary?

Naming a beneficiary lays out your plan for leaving an inheritance and helps get the money to the right person quickly. Insurance and financial companies can immediately see who should receive which assets. If you don't name a beneficiary, it gets more complicated.

In this case, a company would typically transfer the money to your estate, and it would go with all your other property. Then your heirs would go through a court process called probate in which a judge reviews your will and figures out how to distribute everything.

Probate takes time and comes with court fees. It's also possible that the wrong person inherits the money. For example, perhaps you wanted your grandchildren to receive your life insurance payout, but instead the court ruling gives the money to another family member. By naming a beneficiary on your accounts, you skip probate and make sure the funds go to the right person.

What Are the Types of Beneficiaries?

There are a few different options when it comes to naming a beneficiary. One option is to split the benefits between multiple people. For example, you could name both your partner and a child as beneficiaries, so they each receive half the death benefit of a life insurance policy, or money that's left in an account when you die.

Another option is to select a backup beneficiary. Your first choice is called your primary beneficiary, and as long as they are alive, they will inherit the account benefits. But if they pass away before you, you could list a secondary beneficiary, which is also called a contingent beneficiary. The contingent beneficiary will only inherit the money if the primary beneficiary is no longer alive.

Choosing both a primary and a contingent beneficiary may be a good idea for married couples. For instance, if each spouse names each other as the primary beneficiary for an account, they could then have a contingent beneficiary in case both spouses pass around the same time.

Finally, you could choose between making the beneficiary decision revocable and irrevocable. If it's revocable, you can change your mind later. If it's irrevocable, you won't be able to change the beneficiary without the chosen beneficiary's permission.

How Do You Pick a Beneficiary?

Naming a beneficiary is relatively simple. You typically just put in their name, Social Security number (SSN) and contact information on the account's beneficiary form. Keep the instructions clear so there's no confusion. For example, rather than writing "my partner," put down their full name and SSN to avoid any confusion.

You can pick any adult to be your beneficiary, but you typically cannot name minor children. If you do, the courts would select a guardian to manage the money on behalf of the minors until they become adults. To avoid court delays, you could pick an adult family member to be your beneficiary, or you could set up a trust or other account to receive the money on behalf of the young children.

After you pick a beneficiary, make sure to review the instructions after major life changes. The beneficiary instructions take priority over your will. For example, if you named a former spouse as a beneficiary but didn't update your accounts after a divorce, they would still inherit the funds even if you name someone else in your will.

Equipped with this knowledge, take the time to decide who your beneficiaries will be earlier than later. This will help ensure that your wishes are clearly defined and that your assets go to the right people or entities after you pass.