Thinking About Primary and Secondary Beneficiaries
Life insurance is bought with the best intentions of the family as its first and foremost objective.
Most people don’t really give a thought about the beneficiary’s portion of their policy.
In most instances, we name our spouse as the primary beneficiary of our life insurance policy.The majority of insurance companies would also ask that you name a secondary or contingent beneficiary.
Most of us think we want to keep it in our immediate family, so we name the eldest child or all of the children as secondary beneficiaries.
Sounds pretty reasonable and straightforward, doesn’t it?
What could go wrong? I hate to tell you this, but things could go wrong if you make a wrong move.
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Life Insurance Dilemma: Two Scenarios
There are two types of scenarios to consider.
This includes homes with two parents and homes with a single parent.
With two-parent families, we tend to find it unlikely that both parents will die simultaneously or within very short periods of each other, but it does happen.
On the other hand, there are many single parents out there, and they might be disinclined to name the other spouse as beneficiary.
In both instances, the insured parent will likely mark down their child or children as either a contingent or as primary beneficiaries.
Both scenarios can be problematic.
First off, did you know that in the majority of states, under aged children cannot be recipients of life insurance benefits until they reach the age of majority, which is normally either 18 or 21 years of age, in most states?
If the children are minors, they will not receive the money until they reach the age of majority.
The reason behind this is simple, what would a 14-year old do if they suddenly receive a windfall of a $250,000? Let your imagination wonder what they would do.
Many states utilize UTMA (Uniform Transfers to Minors Act).
This allows you to transfer the life insurance proceeds to the person you have designated as the minor’s custodian.
The custodian will be allowed to use the funds for the needs of the minor as the property is held by the custodian until the minor reaches the age of majority which could be either 18 or 21 years of age, depending on the State in which they reside.
The benefits of a UTMA is that the proceeds will avoid probate and is not subject to the claims of creditors.
The problem with this is that a UTMA arrangement is not flexible in that the minor may not use the funds responsibly when they reach the age of majority, so it makes better sense to set a trust instead which would then designate a “trustee.”
A trust provides you with a better means to customize how the life insurance proceeds will be dispersed to the child when they reach the age of majority along with any needs they require when still a minor.
Life insurance is intended to help the surviving children financially, but the law realizes that young people may not be that fiscally responsible.
Life Insurance Beneficiaries: The Court Intervenes
So, what happens? If you haven’t taken the time to name a specific guardian or someone to act as a trustee, the court will do so of their own volition.
If you haven’t designated a guardian or trustee, the courts will decide.
The person they name to act as guardian could end up being the last person you want to be responsible for the money.
Also, the courts could also seriously impose restrictions on how the insurance proceeds will be spent or distributed.
These types of scenarios have led to many severe family financial difficulties and interminable legal squabbles.
How can you avoid this from becoming a problem and ensure that your children are best protected?
Special Needs Children
Another thing to keep in mind is that if you have a special needs child, any funds that they might inherit from you as the named beneficiary might affect any government support they are receiving.
The end result is that if you name them as beneficiary, they still might not receive any money for years until they reach the age of majority in the state they reside.
The inheritance may affect whatever government assistance they could be eligible for which could impact their education, housing expenses and their overall quality of life.
Things You Should Not Do
There are several approaches which you should not take when considering minor children as these options can be costly and problematic.
- Do Not Designate a Friend or Relative - Relative as Guardian Although you might be inclined to have a close friend or family member act as guardians for a minor, this could be problematic if the individual you select has creditor problems, or if they subsequently go through a divorce.
And, there is always the unfortunate possibility that the relative or friend you choose is not as trustworthy as you thought and could use the proceeds for their own purposes.
- Do Not Designate Your Estate as Beneficiary – Never name your beneficiary as your “Estate.” This could result in having life insurance proceeds be subject to your probate creditors.
The money you intend for your children will be tied up in court proceedings and will be delayed until the creditors’ waiting period has expired, and could result in a significant reduction of funds for your children after probate is settled.
- Avoid Using a Testamentary Trust – Generally, the application for the proceeds using this approach could also require the estate being subject to probate which could result in delays as the legal issues are sorted.
You could go this route, but it has to set up precisely and should only be considered with the advice and guidance of an estate attorney. Many experts suggest that the same terms you set up for a Testamentary Trust could be better applied to a “separate Living Trust” instead.
Worst Case Scenario: How to Deal with It
The answer is not all that complicated.
To guarantee that your children get the best protection in a worst case scenario is to designate someone to act as both a guardian and trustee of the estate, or to designate someone to act as a guardian and any other person or entity (such as the family lawyer) to act as a trustee.
By setting up a trust for the distribution of the insurance proceeds you can stipulate quite clearly how and for what reasons that money can be accessed for your children until they reach the age of maturity.
The provisions and requirements for this may vary somewhat from state to state so you should do some research before you proceed in setting up a trust or designate someone to serve as a guardian.
A guardian alone may not necessarily be sufficient depending on the laws of the state in which you reside.
A guardian may have limited or even no access to funds if a trust or trustee has not been set-up or appointed.
To set up a living trust, you might be best advised to talk to a lawyer who specializes in estate law.
Life Insurance Beneficiaries: Just a Minor Problem?
Generally speaking, although your intentions might seem that you have the best interests of the children in mind; it is not advisable to name your children as beneficiaries when you buy a life insurance policy.
If you need more information on this, you can also feel free to ask questions of your insurance agent or someone such as yours truly, Chris Huntley, to fully understand the ramifications and problems which might occur when naming your children as either primary or contingent beneficiaries.
Call me today at 877 – 443 – 9467 today as we can help!