Taking out life insurance is one of the best ways to financially protect your children should something unforeseen happen to you. And, when you're setting up the policy, selecting the beneficiary might seem like a minor detail.  But if you’re not careful about your choice, it can result in a host of unintended consequences.

And if your kids are still quite young, this decision takes on extra importance.

Not Just Your Young Children

Often, parents make their children the beneficiaries of a policy, without giving it much thought. But by law, insurance companies can’t hand out money to minors. So the court would have to appoint a guardian to oversee any assets on their behalf.  That can be a lengthy process, and one that typically requires multiple court dates. It also eats away at the life insurance benefit, because your next of kin will likely have to engage an attorney to represent them in all those court dates. 

If you’re happily married, the obvious choice is to make your spouse the primary recipient of any death benefit (assuming, of course, that you’re confident in his or her ability to handle a large lump sum). But what if you’re a single parent – or you want to plan for the possibility that you and your spouse both die prematurely, leaving your children orphaned? 

The easiest, and typically least-expensive, option is to designate a trusted adult (close friend or relative) to oversee the disbursement of the insurance money for them. If you go this route, be aware that you’re putting a lot of faith in this person’s judgment. He or she has a lot of discretion in terms of how the funds are spent. Choosing this kind of trustee only makes sense if you have a lot of confidence in that person's ability both to handle money prudently and to respect your values and wishes in your children's upbringing. 

When to Create an UTMA Account

One way to avoid unnecessary complications is to set up a Uniform Transfers to Minor Act (UTMA) account. Under this arrangement, the insurance proceeds go directly into the account, and you assign a custodian to manage the assets on your offspring’s behalf. When your son or daughter reaches adulthood – age 18 to 25, depending on the state – they receive any remaining funds.

The biggest problem with UTMA accounts is that they don’t provide much flexibility. Suppose you don’t want your child to receive a giant pile of cash when he or she turns 18. What then?

For that reason, these accounts make the most sense if you have a relatively modest death benefit – say, $100,000 or less – and the children are relatively young. In that case, most of the money is likely to be spent during their upbringing. So there’s less fear of leaving young adults with more money than they can really handle.   

Every state except South Carolina currently recognizes UTMA accounts. All you have to do is contact your life insurance provider; most are equipped to set up one for you. 

When a Trust Is Better

Another alternative is to create a trust that becomes the beneficiary of your insurance policy.

The advantage is that you have more discretion as to how and when the money gets distributed. Say, for example, that you have two children who stand to receive $200,000 each from your life insurance contract. You'd rather they not get the money all at once, and not until they've reached adulthood. You can instruct the trustee – the person managing the trust – to dispense $50,000 on their 20th, 25th, 30th and 35th birthdays. 

If there’s a drawback to trusts, it’s their price tag. Typically you would have an attorney draw one up, a process that can easily cost more than $1,000. There are less expensive ways to set up a trust: legal software products, including Quicken WillMaker and LegalZoom, for example. Or you could take standardized language, which is readily available online, and customize it with your personal information. 

Trusts can also incur ongoing administrative or custodial costs. But, if you’re leaving behind a policy with a rather large face value, it can be a valuable tool, and the few hundreds in expenditures become negligible over the long run. For more details, see 7 Reasons To Own Life Insurance in an Irrevocable Trust.

Find a Good Overseer

Don’t think you need to find a financial expert to be your custodian or trustee. Whomever you choose has the opportunity to hire professionals who can advise on how to invest and manage the inheritance. Your main challenge is to find someone who’s not only trustworthy, but has the common sense to get outside help when necessary.

Ideally, this is the same person who will serve as your kids’ guardian in the event of your death, although it doesn’t have to be. If the person you designate to care for your children is prone to making poor financial decisions, it might be a good idea to find someone else for the role of property manager. Just know that the better these two people get along, the better off your children will be.

Update the Paperwork 

Regardless of how you set up your will (see Why Your Will Should Name Designated Beneficiaries), you have to make sure the beneficiary paperwork from the insurer is accurate. Otherwise there’s no guarantee that the person you want to receive the funds will actually get them. 

If you need to amend the contract to reflect a different beneficiary, ask for a change-of-beneficiary form from your agent. Making the update is usually a pretty simple process. 

Keep in mind that you should name a secondary, or contingent, beneficiary too. That way, if the primary recipient dies before or at the same time you do, the insurance benefit can still avoid probate

The Bottom Line

Selecting beneficiaries might seem like a minor detail when you set up your life insurance policy. But failing to understand the implications of that decision can lead to a very different result from the one you’d want.

If you’re not careful about your choice of beneficiary, it can take a while before your offspring actually receive any money. Or the funds could end up in the hands of someone who’s unprepared to handle the responsibility.




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