There are many people who want to have a minor or their child as the beneficiary of a life insurance policy. Is leaving life insurance to a minor a good strategy? This is an important question to ask and choosing the proper beneficiary is key.
Life insurance is supposed to pay for the things that may cause a financial burden for your family. Many times, those financial hardships are things like health care, education or college tuition for your children. You’re planning on covering those expenses, which is needed, but you shouldn’t have your children paid directly with your life insurance death benefit.
There are a few reasons why this is a bad idea.
First, you need to think about the difficulties of a child managing a large amount of money at a young age. Secondly, you have to understand that there are legal measures in our country to make sure the first example is prevented. This post will go over everything you need to know about minors as beneficiaries of life insurance.
Purchasing Life Insurance for a Minor
Unfortunately, purchasing life insurance for a child is frequently confused with having the child as the beneficiary of your policy. This, along with buying a separate life insurance policy on a child is not a good strategy.
Life insurance is designed to reduce the financial risks and burdens of your beneficiary’s because they depend on you. Since children don’t have anyone that depend on them financially, it’s not always a great idea to get them their own policy.
There are exceptions!
If your child has special needs and has long term medical needs that will make it very difficult or impossible to buy in the future. It will be less expensive to buy a life insurance policy as a child, but you’ll need to purchase a permanent policy such as Universal Life or Whole Life instead of Term life insurance.
A permanent life insurance policy provides lifetime coverage so you won’t have to worry about the severity of their medical condition and if it will make them uninsurable at some time in the future. By doing so, you’re providing protection if their health becomes much more serious years down the road. The major drawback to this is that permanent life insurance is quite costly.
If the policy is too expensive, you can opt for a child rider to your life insurance policy. A life insurance rider provides your base policy with some extra coverage. With a child rider, your policy adds coverage for your child at a much cheaper cost. The drawback? The maximum death benefit is not very large compared to an individual life insurance policy.
What is a Primary and Contingent Beneficiary?
At some point, you’ll need to decide who will be the beneficiary or beneficiaries of your life insurance policy?
What is a primary beneficiary? A primary beneficiary is someone who will be the 1st in line to get the death benefit of your life insurance policy. The most common primary beneficiary of a life insurance policy is a spouse. You can have more than 1 primary beneficiary. For example, perhaps you aren’t married and want to have a 50/50 split of your death benefit with your 2 siblings. Your siblings would be your primary beneficiaries.
What is a contingent beneficiary? A contingent beneficiary does not receive any of the death benefit if the primary beneficiary is alive when you die. The contingent beneficiary will only get the death benefit proceeds if your primary were to die first. Here’s an example: Let’s say you named your wife as your only primary beneficiary and your children as the contingent beneficiaries. You and your wife get into a car accident and die- your wife obviously can’t receive the death benefit. It would now go to your contingent beneficiaries – your children.
This sounds like a good strategy?
Not really. Things can go wrong if you don’t set this up correctly.
What will happen if I name my child as a Primary Beneficiary?
There’s no doubt that your children are potentially the number one reason why you’re buying a life insurance policy. After your spouse, they’re probably the next in line to include on your policy. You want to protect them financially and life insurance is a great way to do this.
The problem is if your children are still under 18. When your children are minors, you will need to prepare properly to make sure they receive the death benefit the way you want it.
Life insurance companies simply won’t pay a death benefit directly to a child until they have reached specific age. This age is based on the specific state you reside in and can range anywhere between 18 – 21.
What will happen if I name my child as a Contingent Beneficiary?
You’ve applied for life insurance and now need to choose your beneficiaries. Your life insurance company will want you to choose primary and contingent beneficiaries. Remember that the contingent is to provide protection in case your primary beneficiary dies when you die (car accident, plane crash, etc.).
By naming your children as contingent beneficiaries, you’ll be able to keep the money in your family instead of your estate. If it went to your estate, your death benefit could end up paying for things you don’t want it to pay for. Things such as legal fees and paying off debts. Selecting contingent beneficiaries is a good strategy to make sure your death benefit is controlled by you.
Why choosing a child as your beneficiary is a disaster!
Even though it is possible to select your children as your life insurance beneficiaries- it’s a really bad idea.
First and foremost, if you were to die and your child is a minor, it’s going to be really hard for them to collect the benefit. Remember that a life insurance company can’t pay a death benefit until a beneficiary has reached the “age of majority” of 18-21.
If you die, you’re going to give the power to decide where the life insurance benefit ends up. This power is given to the probate court. What a nightmare!
The probate court will first name a guardian for the estate of your child. The guardian will make the decisions of the estate until your child reaches the age of majority.
It Get’s Worse!
The legal guardian that the court appoints may not even be the surviving parent. This is uncommon, but is possible and they would have to go through a petition to the court. If you’d like to choose someone other than the surviving parent to be the guardian, you need to make sure you specify that in your policy.
Not only is this scenario not ideal, but it is costly too. There will be associated fees that are tacked on in order for the court to manage the asset distribution. All of this can make an already stressful situation worse because the funds could be tied up for years. This could possibly be an ongoing issue that may not end until the child meets the age of majority criteria. Add up all of these inconveniences and the end result may not be exactly how you wanted the benefits to be passed down to your children.
What about appointing my own trustee before I die? Can’t my trustee be instructed how to distribute the death benefit to my child?
You could, but it’s not that easy.
Each state has laws that will limit exactly what expenses the funds will be able to pay for. Designating your spouse as the life insurance beneficiary is a good option just as long as you trust their decision making. That may sound harsh, but we all know some married couples who may not have the best financial IQ.
Dependents and Minors: What’s the difference?
A minor is someone whose age is less than the “age of majority”. Remember that the age of majority is determined by each state, but is typically 18-21. A dependent is a person who has to rely on you for financial support and care.
Look at it this way:
- Everyone who is a minor is also a dependent.
- However, not all dependents will be a minor.
Make sure that you buy enough life insurance to cover every one of your dependents no matter if they are a child, an adult or someone with special needs.
Life Insurance Trusts and Legal Entities
When you die and your beneficiary is still under the “age of majority” – your death benefit is designated to the court appointed guardian or custodian. They will get a custodial account or life insurance trust to put the death benefit into and receive the death benefit payout as the named beneficiary.
Your custodian will own this account until your child meets the age majority. At this point in time, your child will then own the account. The main ways that the custodial account is used is to pay for your child’s expenses. This is typically for common scenarios like educational expenses, but can also be for eligible expenses such as your child’s cell phone bill.
There are two acts that help define what is an eligible expense. These acts are:
- Uniform Transfers to Minors Act (UTMA)
- Uniform Gifts to Minors Act (UGMA)
Choosing Children as Life Insurance Beneficiaries: 5 Mistakes to Avoid
Here are 5 ways that you may choose a minor, or your child, as the primary or contingent beneficiary.
1. Living Trust
Make a Living Trust: Living trusts could be described as flexible and ideal when it comes to designating a minor as a beneficiary. With a living trust, you’re not going to be subjected to probate like other scenarios. You can setup the terms and conditions and plan accordingly. If you foresee issues with estate taxes you can opt for a irrevocable living trust. This can be used to own your policy and also manage the death benefit after you die.
Final thought: The most ideal
2. Testamentary Trust
Make a Testamentary Trust: With a testamentary trust, you’ll create a trust in you will that will be funded after you die. You could then designate your beneficiary. If planned properly you could potentially avoid causing the benefit going to the estate creditors and creating an inflexible estate for your child. There could be some delays due to probate. This option is not the best, but definitely not the worst.
Final thought: Ok, but not ideal.
3. children as primary beneficiaries
Choosing your children as primary beneficiaries: If your children are minors the insurance company can’t cut a check to your children. Even if you have a trust or will, it won’t protect you from everything. That’s unfortunate. The company will require a guardian. This court appointed guardian of your child’s estate is not automatically a surviving parent. A personal guardian and a surviving parent are not one in the same. The court appointed guardian is in charge until your child reaches age of majority. All of this is a huge pain. It delays everything and isn’t free. The big losers in this scenario are special needs children and young adults.
Final thought: Complicated and potentially expensive.
4. basic Will
Using a basic Will and designating your estate: Remember our earlier example about the court appointed caregiver? Here it is again. If you don’t clearly setup your beneficiaries appropriately or you designate your estate- the benefit will go to the court appointed caregiver of your probate estate. Also, if your will isn’t clear about the beneficiaries who are minors- your children will have to have an estate opened.
Final thought: Potential Nightmare
5. Choosing a friend or relative
Choosing a friend or relative because you feel they will follow through your wish to use the death benefit for your kids: Sometimes it may seem like a no brainer to name a friend or relative that you trust as your beneficiary. You leave it up to faith and chance that they make sure the death benefit is spent correctly and appropriately. However, there are so many things that can go wrong with this scenario. What if they aren’t as trustworthy as you believed? What happens if they have family issues or go through a tough financial time? What happens if they happen to pass away?
Final thought: Do Not Designate a Relative/Friend.
Leaving Life Insurance To A Minor
The Bottom Line: Protecting your children is the goal for almost every parent. You want to make sure they’re not going to go through financial hardships if you were to die. Making sure they get your policy death benefit as you intended is important, but selecting them as the beneficiary is not the best strategy.
Please contact us if you have any questions about leaving life insurance to a minor, or anything life insurance related.