Why you should NOT name your kids as beneficiaries on your life insurance
As an estate planning attorney, I know my clients’ wishes come from a well-intentioned place, which is to leave a monetary legacy, via life insurance, for their minor child(ren), should they become incapacitated or pass away. However, I have to break the reality to them every time:
DON’T do it!
At least don’t rush into it …
If your child(ren) are minors* they cannot receive a benefit pay-out until they’re 18 years old- even from life insurance. The only way your minor children can receive benefits is to appoint a legal guardian. This is a complex (and costly) process that requires a public court proceeding with a judge to oversee how the inheritance is distributed when they turn 18. Even then, the guardian will have to distribute the money directly to the child when they turn 18…to spend as the child wishes. This often leads to another situation you want to avoid.
Let me share with you an all-too-common scenario of what happens when your child turns of age and receives their inheritance and (let’s be honest) have little to no financial understanding. I recently handled a case where a parent died and left a large inheritance for the son. When the son turned 18, he inherited tens of thousands of dollars. The first thing he did was go out and spend all of his inheritance on a motorcycle and a ring for his girlfriend. I am sure you know where this story is headed- he crashed the motorcycle and his girlfriend kept the ring after they broke up.
How do you avoid this?
A common way to address this issue is to set up a trust specifying that the child(ren) inherit from the trust. You then name the Trust as the beneficiary of the life insurance. That way, you are putting your life insurance and other assets (such as your car, home, etc.) under the control of the trust (and not the court!).
If you should become incapacitated or pass away, the designated trustee then manages the distribution of the inheritance. This will also protect your assets from having to go through probate court- which will be costly and time-consuming for your loved ones.
The great thing about a trust is it is set-up on your terms. In other words, you specify the parameters of the inheritance (i.e.: age the child must be to receive the money or following college graduation, etc).
Finally, there are many other benefits to consider when setting up a trust such as:
- Tax benefits
- Avoiding costly probate
- Can be beneficial during illness, not just death
Recap: Do not rush into putting your minor children as beneficiaries without considering setting up a trust. Your best bet is to consult with an estate planning attorney.
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*Under 18 or 21 years old, depending on the state you live in.