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6 Ways to Designate Minor Children as Life Insurance Beneficiaries: the Good, Bad and Ugly

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Many new or expecting parents wisely include obtaining life insurance policies on their to-do list. Protecting the financial security and future of minor, young adult and disabled children from a parent’s untimely death is critically important. But, selecting and obtaining the right policy is only half of the equation. It is equally critical to designate beneficiaries properly. Purchasing a policy to protect your family but neglecting to properly structure the beneficiary designation and related estate planning documents is like wearing suspenders without the belt.

Below are 6 ways to designate minor (and also young adult and disabled) children as either primary or contingent beneficiaries. Every situation is unique, of course, but the list below starts with generally the very worst method and ends with the best.

1)  Designate a relative or friend and hope that they will honor your wishes and use the proceeds for your children.  Some parents are aware that naming minors directly as beneficiaries is a bad idea (it is, see #3). As a shortcut, they might simply name a trusted relative or friend as beneficiary and hope that they expend the proceeds for their children appropriately. The what-if’s that can go wrong are numerous and onerous. What if the trusted person has creditor problems? What if they’re going through divorce? What if they die? What if they’re not as trustworthy as you thought? I think you see the point. Verdict: Don’t do this.

2)  Designate “My Estate” with no will or a ‘simple’ will.  If you either designate ‘my estate’, fail to name a beneficiary or all named beneficiaries predecease you, then the proceeds will be paid to the court-appointed representative of your probate estate. Even if you are not otherwise planning to avoid probate, this is a bad idea. Doing so will unnecessarily subject the insurance proceeds to your probate creditors. Moreover, the availability of the proceeds to help with the care of your children will be subject to substantial delay, both in terms of opening the estate and waiting out the creditor claims period. Finally, if your Will doesn’t specifically provide for shares of minor beneficiaries, a minor’s estate will have to be opened, with any remaining proceeds paid out to the child in full at age 18. Verdict: Could be a disaster.

3)  Designate minor children directly as beneficiaries.  It should come as no surprise that a life insurance company cannot write the check payable to your 5-year-old. You might assume if you have a Will or Trust that it will automatically cover everything. It won’t. The beneficiary designation controls. I’ve seen this mistake cause confusion frequently. So what will the company require? A court-appointed guardian of the minor’s estate. A surviving parent or personal guardian is not the same and is not sufficient. Probate court will have to be petitioned to appoint an estate guardian over which the court retains oversight until the child reaches 18, at which time the proceeds must be turned over in full to the child. This process adds delay, cost and administrative burden. Young adults and disabled children receive no protection. If your children (and children of any deceased children) all happen to be adults fully capable of receiving their full inheritance outright then this option may work out. Verdict: Unnecessary complication, expense and inflexibility.

4)  Designate a testamentary trust for the benefit of children.  The terms of your Will can be written to create testamentary trust (a trust created within your Will and funded after your death). If that is the case, you could designate the beneficiary as, for example, “the then acting trustee of the trust created under Article X of my Will”. If executed successfully, this should avoid subjecting the proceeds to estate creditors and forcing an inflexible minor’s estate. On the downside, application for the proceeds will generally require probate and be subject to potential delay. Moreover, thorny issues could be created if the referenced Will is revoked, lost or otherwise held invalid. While better than the prior options, we typically don’t favor testamentary trusts because the same terms can be more easily incorporated into a separate living trust that is private and can avoid probate when properly funded (See #6). Verdict: Less ideal than living trust.

5)  Designate children subject to UTMA custodian.  The problems associated with naming minor children directly as beneficiaries are detailed in #3 above. In sum, there must be an adult in charge. One way of accomplishing this goal is to designate that the proceeds are paid to an adult custodian for the benefit of the minor child to be held in a “Uniform Transfers to Minors Act” (UTMA) account. An UTMA account is essentially a type of statutory trust. The designated custodian is given the discretion to make distributions for the minor’s welfare. At Age 21, the account must be fully paid to the child. This arrangement avoids probate, avoids a minor’s estate and is not subject to creditors. However, the arrangement is not flexible or customizable like a trust. The designation and succession of the custodian can be a bit trickier than a successor trustee.  An account can only have one beneficiary, as opposed to a trust which may be held for multiple beneficiaries.  And ultimately, a trust can be extended beyond 21 for a variety of reasons, whereas an UTMA account cannot. Verdict: May be sufficient when the proceeds are modest or when flexibility is not critical.

6)  Designate your Living Trust as Beneficiary.  The ideal and most flexible beneficiary for life insurance proceeds is a living trust. A living trust is not subject to probate, so the delay and costs associated with probate do not apply. Within the structure of a living trust you are able to detail the terms and conditions of gifts and plan for ever contingency. If you have multiple minor children, you might create a pot trust. If you have special needs or spendthrift beneficiaries, you can plan for that as well. It is much easier to engage in more detailed planning and create different distribution schemes that might be impossible within the confines of the life insurance company’s simple beneficiary form. If you want to change or alter the distributions, you need not change every policy, you only have to amend your trust. In addition, designating your trustee to collect the proceeds is going to be simpler than having multiple beneficiaries all having to submit forms to collect. If estate taxes are an issue, a special type of irrevocable living trust may be used to own the policy and then to manage the proceeds after death.  Verdict: Ideal option.

Don’t allow estate planning and beneficiary designations to be only an afterthought when you consider and obtain life insurance.  Be sure to discuss the beneficiary designation with your estate planning attorney and create or coordinate the designation in conjunction with your estate plan.