A lot of people get life insurance and want to name their kids as the beneficiaries. Good idea!, we say whole-heartedfly, but with some minor adjustments.
It’s actually a terrible idea to directly designate your kids as beneficiaries, at least while they’re minors. Turns out, you can’t just give a kid a million bucks (we tried). But if you still want your child to directly benefit from your benefit, there are a few ways you can make sure the money reaches them.
What happens if you name a child directly?
A probate court will decide who is the guardian of the minor’s estate. Sounds bureaucratic, doesn’t it? It is! Before the life insurance company will give out any money, a probate court needs to be petitioned to name a guardian, over which the court will have oversight until the child reaches the "age of majority," which honestly sounds like the next Avengers movie. The age of majority is different for every state, but is usually 18 or 21.
It doesn’t matter if there is a surviving parent or if you’ve appointed a personal guardian in your will – life insurance companies won’t pay the money to them.
This means your survivors will have to pay attorneys’ fees, sit through court proceedings, and deal with court supervision of life insurance benefits. This can cause a huge delay and create an unnecessary bureaucratic nightmare, which is a headache for your family and potentially dangerous if you have disabled children whose continued care will depend on that money.
One solution: the Uniform Transfer to Minors Act
The Uniform Transfer to Minors Act (UTMA) is one of the easier ways to ensure that your kids get the benefit amount with the least amount of bureaucratic overhead. Here’s how it works:
- You, loving parent, buy a life insurance policy and name your child the beneficiary.
- While you’re doing that, tell your insurance company that you want to designate a UTMA custodian and UTMA account. Your life insurance company will help you fill out the proper forms.
- Set up that UTMA account at the life insurance company or at the bank or financial institution of your choice. You can do this before you buy a life insurance policy.
- Make sure that the person knows that you’re designating them as a custodian, otherwise if you die they’ll be like, "Wait, what?"
Basically, what you’re doing here is setting up a guardian for your child’s benefit. What makes it different from what the probate court does? Instead of a court deciding, you get to decide, and the courts have no say in it. Plus, it all happens without the major delay of going through the justice system.
Like the court-appointed guardianship, UTMA guardians must transfer the funds to your kids once they reach adulthood.
Since UTMA guardians aren’t being monitored by a third-party, there is the potential for negligence on the part of the UTMA guardian. Make sure that you choose your child’s UTMA guardian wisely, and sit down together to make sure you’re both on the same page about how the money should be used. You may find it helpful to write up a contract, however, the contract will really only be useful if someone needs to sue the guardian in order to force them to resign (unless you want to come back as a ghost and haunt them if they break the contract).
UTMA guardianships don’t make sense for everyone. They’re generally pretty inflexible. You don’t get to control when the money goes to your child, so if you’re giving them a very large chunk of change, they could mismanage it once it gets into their hands. In addition to that, UTMA guardianships are complicated if you’re giving money to more than one beneficiary, so if you have multiple kids, you’ll probably want to look at...
A Living Trust
Creating a living trust isn’t as complicated as it sounds, and if you have multiple children or beneficiaries, it’s the easiest way to distribute your life insurance benefit. Here’s what you need to do:
- You write up some trust documents (maybe get a lawyer to help out with this one). in those trust documents, include a few key details:
- How you want the life insurance benefit to be distributed to your various beneficiaries
- An adult who will manage the funds, which may include some form of UTMA guardianship or child’s trust
- Buy a life insurance policy and name your trust the beneficiary. Give a copy of your trust to the life insurance company.
- Sit back and think to yourself, "Wow, I’ll really do anything for my children."
While you can give money to multiple kids using just UTMA guardianships and no living trust, doing so is complicated. A living trust makes things easier to execute and is simpler to understand.
Or a Testamentary Trust
A testamentary trust is a trust that you set up when you write your will. Unlike living trusts, testamentary trusts come into existence and are funded after your death. The process to setting one up is similar to a living trust – basically, talk to a lawyer.
Testamentary trusts have some downsides compared to living trusts – they still have to go through probate courts, for example – but for people giving smaller amounts of money, they’re a good option.
Ask a financial professional for help
Everyone’s situation is different, and you probably have a lot of questions that can’t fit into this article. If you’re in the process of buying life insurance, you should ask your life insurance broker or agent for help. They’ll be able to help decipher your company’s specific policies and your state’s laws.
If you’re looking for help specifically regarding your end-of-life plans or estate planning, talk to a financial planner and find a lawyer. They’re your best resources for building a comprehensive end-of-life safety net.
Image: Vladimir Pustovit