The title may be, and hopefully is, a bit of a wake-up call to parents of young or not quite responsible yet children. For the typical parent who is trying to make sure their kids are provided for even if they don’t survive to see it all, the kids are named as direct beneficiaries of life insurance policies.
When applying for the life insurance, the agent asks “who do you want to receive the death benefits?” The parent says either “my kids” or “my spouse and then my kids.” So the agent fills in the spouse as the primary beneficiary and the kids as contingent beneficiaries, or maybe the kids as the primary beneficiary. Sounds like a good idea, right? WRONG! Well, kind of wrong – it could be worse, you could not buy life insurance at all or you could name Charles Manson as the beneficiary. But it could also be much better. Let’s discuss the ramifications if the parent actually does die and this life insurance policy is set to pay out:
The life insurance company will cut a check to the named beneficiaries and the named beneficiaries only. So, if you named your 4 and 6 year old children, guess who the check is made out to? That’s right, one check for the 4 year old and one check for the 6 year old. What happens when the children try to deposit their checks? They can’t. The children have to have a guardian or conservator who can take custody of the funds for the children’s behalf until the children turn 18. What’s so bad about that?
For starters, the parent has no control over who will step up to be the guardian or conservator. Hopefully someone does it, and hopefully it is someone who is trustworthy, good with money, and has the children’s best interests at heart. And what exactly does this person have to do to become guardian or conservator?
They have to petition the court, go through some background screening, and post a bond (similar to buying insurance over the total value). Some children don’t have any adult relatives who have strong enough credit to obtain a bond, or who have enough cash to pay the premium on the bond. Too bad for those kids, the money will likely sit with the insurance company until the child turns 18. But what if that person does get the bond and does get the court to appoint them as guardian or conservator, what then? Then that person must report to the court every year to document what all they have done with the children’s money each year (probably paying a lawyer to assist with this each year). And then, when the children turn 18, they get all the cash!
Ask the parents you know if they would want their children to receive a large sum of money at age 18 – the vast majority will say no way, they need to wait til 30, maybe 25, maybe til they finish college, but not 18. Okay, so you’re probably now convinced that it is not a good idea to name minor children as beneficiaries of life insurance policies, but how then does one make their life insurance proceeds available for their minor children?
The parent drafts and executes a trust, or a will that establishes a trust for the children’s benefit. The parent names the trust (or the trust under their will) as the beneficiary of the life insurance policy. In that trust, the parent gets to name who will be in charge of the money for the children (the trustee), the parent gets to relieve that person of reporting to the court or going through background checks and bonding agencies, and the parent gets to set the terms of that trust. If they don’t want their kids to have full control and access to the money until age 30, they can draft that into the trust. If they want their children to be cut off from the trust’s funds if they don’t stay enrolled in school until they graduate with a four year degree, they can draft that into the trust. The parents can draft whatever they want to in the trust. That surely beats the alternative of leaving it up to another adult to go to court make sense out of the process, and then leaving it up to their 18 year old child to make good life decisions with a bundle of cash at their disposal.
If you are a parent, you get a C+ for buying the life insurance (and the life insurance agent gets their commission), you get a B- for drafting and executing a trust for your kids or a will establishing a trust for your kids (and the lawyer gets paid for the document), but the only way you get an A+ is if you actually direct your life insurance proceeds into your trust! Neither your life insurance agent nor your lawyer get paid extra for helping you coordinate the two, but both of them should be instructing you to do so if they are at the top of their profession.