Leaving Money to Minor Children Can Cause Major Problems

What would happen to your children if anything happened to you? That question strikes fear into the heart of many parents, and is the number one reason parents of young children give for purchasing life insurance. You want your kids to be well-provided for growing up, and to be able to go to college. If you’re around, you can meet those needs and work to save for the future. If you’re not, life insurance may be the only way to make sure your children have the life you want for them.

So, naturally, you should get the biggest life insurance policy you can afford and name your kids as beneficiaries, right? Wrong. While having life insurance for the benefit of your minor children is a good idea, making them direct beneficiaries of your policy could cause big headaches. The same is true of naming your child a secondary beneficiary on your IRA.

The Most Common Life Insurance Mistake People Make

Here’s how the scenario usually plays out. You and your spouse have a baby, and realize that you really need to get, or increase, your life insurance. You sit down with an agent and choose a policy. Naturally, your spouse is your primary beneficiary. After all, if anything happens to one of you, the other would need the policy benefit to care for your little one.

The agent, pen poised, asks you to identify a secondary beneficiary, in case your primary beneficiary is not alive at the time of your death. There’s only one logical answer, you think: if my spouse can’t collect my life insurance, it needs to go to my child. After all, it’s for our child that we’re getting insurance in the first place. The agent doesn’t blink, but includes your child’s name as secondary beneficiary as you request. You take your policy and file it away in a safe place.

Here’s what your insurance agent didn’t tell you. If you and your spouse both die, and your child is a minor, the money will not go into their hands; they are not legally capable of managing it.

Did you just think to yourself, “No problem! I also have a will, which names a guardian for my child. The guardian will handle the money.” That seems like a reasonable plan, but you haven’t connected the legal dots to make it happen. If your child is named as secondary beneficiary, the life insurance company can’t just hand over the proceeds of your policy to the guardian. It must be turned over to the Probate Court. This is so even if you’ve specified otherwise in your will, because life insurance proceeds are distributed without reference to instructions in a will.

Now the Probate Court must appoint a conservator for your child’s assets. This may or may not be the same person you would have chosen. In addition, once a conservatorship is established, it is necessary to continually report to the court, creating court costs and attorney’s fees. This will continue until the child becomes a legal adult at the age of eighteen in Michigan.

Eventually, the proceeds of the policy will probably be put into a custodial bank account for your child—after thousands of dollars in legal fees, taken out of those proceeds, have been spent. Even if you don’t mind that prospect, consider this: the minute your child turns eighteen, they’ll have access to every penny in that account. Think back to yourself on your eighteenth birthday. If you’d suddenly been handed $200,000 free and clear, would you have spent it wisely?

At this point you’re probably picturing your eighteen-year-old speeding down the highway in a brand new Mercedes convertible, swigging Dom Perignon while the hundred dollar bills piled in the back seat fly out on the breeze like confetti. So what do you do in order to change this picture?

Making Sure Your Children Get Your Life Insurance or IRA Funds

If you’re buying life insurance for the benefit of your child, there are a number of ways to make sure it does what you intend. Some of these are only a little better than designating a minor child as a beneficiary; others are more likely to achieve your goal.

If you’re buying life insurance for the benefit of your child, there are a number of ways to make sure it does what you intend.

One of the riskier options is to name your estate as your secondary beneficiary. If you do this, proceeds from your life insurance policy will be distributed as your will directs. However, because they have been made part of your estate, they are now subject to probate. Also, unless your will directs that these funds be placed in a trust until your child reaches a certain age or milestone, your child will still be able to access the funds when they turn eighteen.

A better option is to establish a revocable living trust during your life. In the trust you name a more responsible individual (called a Successor Trustee) to manage any inheritance left to a minor or immature beneficiary. The inheritance is typically held in trust and managed by the successor trustee for the benefit of the beneficiary until they reach a more responsible age.

There are other methods by which assets can be gifted to, or left as an inheritance for, a minor or immature beneficiary. Which method is most suitable will depend upon the circumstances, such as when the gift is to take place, tax-related motivations for making the gift, whether the gift is solely for education purposes, age at which you want the funds available to the beneficiary, etc.

There are many ways to make innocent, costly mistakes in beneficiary designations. To learn more about the best ways to use life insurance, or the contents of your IRA, to protect and benefit your family, we invite you to contact us to schedule a free initial consultation.