One of main reasons to buy life insurance is to protect your children in case you can’t be around to provide for them. But one of the biggest mistakes you can make is naming your kids as beneficiaries on a life insurance policy when they are still minors.
Buying life insurance is wise, but you have to be careful when naming the beneficiaries, or you could unintentionally put a hole in your family’s financial safety net.
Why you shouldn’t name minors as beneficiaries
Say, for instance, a husband and wife both have life insurance and name each other as the primary beneficiary and the children as secondary beneficiaries on their policies. If one dies, the life insurance policy pays a death benefit to the spouse, who can use the money to support the family. That’s how life insurance is supposed to work. But what if both parents meet an untimely end before the kids are adults?
The life insurance company can’t pay out the proceeds until the children reach the age of majority, typically 18 or 21, depending on state law, or a court appoints a legal guardian of the children’s estate. The appointment process can be time-consuming and expensive. Money that could have gone to the kids goes toward attorneys fees.
The wait for this legal process to finish could lower their quality of life and delay important milestones, like going off to college.
Naming a custodian
A simple alternative is to set up an account for your children with the life insurance company under the Uniform Transfers to Minors Act (UTMA). The law lets you name an adult custodian to manage the life insurance proceeds for the children while they’re minors. The custodian can use the money for the children’s benefit, such as for housing and education. Once the kids reach the age of majority, the money is turned over to them, and they can do anything they want with it.
A life insurance agent can help you establish an UTMA account when you buy a policy. It might be a good solution if you’re comfortable with the kids getting the remaining proceeds as very young adults.
Setting up a trust
Another alternative is to work with an attorney to set up a trust for the benefit of the children and name the trust as the beneficiary of the life insurance policy. When you set up the trust, you select a trustee to manage and distribute the funds according to your wishes. The advantage of a trust is you can set specific terms for how the money is distributed. For instance, you could set it up so that the money is doled out to your adult children in phases at different ages.
You don’t have that option when naming a custodian under the Uniform Transfer to Minors Act.
Take extra care for children with special needs
If your child has a disability and may rely on government assistance, consult with a special-needs attorney about setting up a special needs trust for the child. The trust can hold assets for the child without disqualifying him or her from important programs such as Medicaid, the federal and state health insurance program, and Supplementary Security Income, which is handled by the Social Security Administration.
Talk to a financial advisor and an attorney to decide the best course of action.
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