Many parents wisely decide to buy life insurance to cover the outstanding mortgage on the house or provide a surviving spouse security in the event of the untimely death of one parent. In addition, parents understand that it is important to plan for the financial future of their young children in the event of the untimely death of both parents. Equally important in this process is the proper designation of a beneficiary for minor children.
The following imaginary couples illustrate the consequences of choosing the correct or incorrect beneficiary for life insurance proceeds:
1. Max and Maureen designate their minor children as contingent beneficiaries.
Max and Maureen are married and have two children, Millie and Martin. Millie is ten and Martin is twelve. Max and Maureen have no will but each has a life insurance policy in the amount of $250,000. They are reciprocal beneficiaries on the policies, with their children named as contingent beneficiaries. Sadly, Max and Maureen die in a car accident while the children are staying with Aunt Matilda. Because the children are minors, Aunt Matilda must hire an attorney to petition the court to establish that she is the guardian of the children, and enable her to receive the life insurance proceeds on behalf of the children. She is a good aunt and is meticulous with preserving the children’s money. When the children turn 18, they each get over $200,000 in their bank account. Martin immediately buys a $60,000 car and decides he is not going to college after all. Millie decides to go on a shopping spree in Europe. Max and Maureen just rolled over in their graves.
2. Hope and Harold designate a friend as the contingent beneficiary to use the proceeds for the children.
Hope and Harold have two year old twins, Henry and Harris. Hope and Harold have a nice home and a mortgage, so they have decided to each take out a life insurance policy in the amount of $350,000. They know they should designate a contingent beneficiary on the policies, so they talk to their friend, John Trust, and ask him if he would be the contingent beneficiary and use the money to support their children if something every happens to them. John is happy to oblige. Unfortunately, Hope and Harold meet their untimely death in a plane crash. John, meanwhile, caused a ten car pile-up on the freeway and has a judgment against him in the amount of $500,000. As soon as the life insurance proceeds are transferred to John’s bank account, his creditors garnish it to satisfy their judgment. John uses the remaining money to take care of the children, but the funds run out before they turn 18.
3. Diana and Don designate “my estate” as the contingent beneficiary.
Diana and Don have a little girl, Debra, and reciprocal life insurance policies. They know they need a contingent beneficiary, so they designate, “my estate.” As a result, if they both die, the proceeds will be paid to the court-appointed representative of the probate estate, and the proceeds will be subject to any probate creditors, including Diana and Don’s medical bills and credit card debt. Little Debra will need to wait at least a year before she sees any of the money to provide for her care. Then, when Debra turns 18, she will be entitled to any and all funds that remain, to spend at her eighteen-year-old discretion.
4. Carl and Christine designate a UTMA custodian.
Carl and Christine have two teenage children and reciprocal life insurance policies. They know they cannot name their minor children as contingent beneficiaries. They talked to their friend who is a lawyer who suggested that they name an adult custodian pursuant to the Nevada Uniform Transfers to Minors Act (“UTMA”). Under the UTMA, the executor of Carl and Christine’s estate can make an irrevocable transfer to a custodian for the benefit of a minor as authorized by their wills. However, each policy must be allocated to a custodian to benefit one child, so if Carl and Christine have a third child, the third child would receive none of the life insurance proceeds. In addition, unless Carl and Christine each state on their contingent beneficiary forms that payment is delayed until the child turns 21, the child will receive all proceeds at 18.
5. William and Wanda designate their testamentary trust as the beneficiary.
William and Wanda follow the advice of their financial planner and hire an attorney to prepare their wills. Because they have three young children, their attorney advises them to have a testamentary trust to benefit their minor children, Wendy, Warren, Wess. William and Wanda designate the trustee of the testamentary trust as the contingent beneficiary on their life insurance policies. Because the trust is testamentary, i.e., effective upon death by terms of the will, their estates will be probated before the trust can be funded with the life insurance proceeds, which will cause delay of funds. However, if something happens to William and Wanda, they know that their children will be provided for by someone they trust, and their children will not come into large sums of money at age 18, because they have specified that the proceeds be distributed at intervals until the youngest child turns 30. William and Wanda do not need to worry about Wendy dropping out of college or Warren buying an overpriced car at age 18 because they inherited a large sum of money.
6. Tina and Troy designate their revocable living trust.
Tina and Troy have a three year old girl, Tessa, and a six year old, Tom. They have wisely hired an attorney to prepare a revocable living trust. In the trust, Tina’s brother is designated as the successor trustee, and, if something should happen to both Tina and Troy, he will manage all the financial matters for the children until the youngest child turns 25. Tina and Troy have designated their trust as the beneficiary for their life insurance proceeds, and, as a result, probate proceedings will not delay distribution of the life insurance proceeds. Like William and Wanda, Tina and Troy have a peace of mind with regard to Tessa and Tom, and they need not worry about their children receiving their inheritance all at once with no controls.
As demonstrated above, the ideal choice for a beneficiary is a revocable living trust. A trust gives parents control of the financial future of their children after their death, and it prevents delay by avoiding probate. A testamentary trust will work, but there will be delay in receipt of the funds due to probate. Beneficiary designation is an important part of the estate plan process that should not be ignored, and anyone with young children and life insurance policies should discuss their options with their financial planner and attorney.
Disclaimer--Nothing herein should be construed to create an attorney-client relationship. Please consult with your attorney with regard to your specific estate planning needs.