There is a potential problem in naming a minor child as a primary or contingent beneficiary on their life insurance policies. If death occurs while your children are still minors, the life insurance company can’t pay benefits until the court appoints a guardian. That takes time and money for attorney fees and court costs. Passing on a lump sum might work if you have a small policy, but would you want your 18- or 21-year-old to get a massive windfall with no strings attached?
Even if your children are responsible, naming a minor child as beneficiary on your life insurance policy can be a problem. Children don’t have the life experience and wouldn’t know what to do with the cash. That lack of knowledge can leave them financially vulnerable. There are other ways to avoid the problem. You could name a trusted adult to be the beneficiary of the policy and trust they will use the money for the benefit of the child. However, there are a couple of other options.
Consider a Living Trust
Trusts aren’t just for the rich they can be essential tools for young families. Instead of naming a minor child as beneficiary on your life insurance policy, name the trust and trustee. If you meet an untimely end, the trustee will manage and spend the money according to the rules you set for the trust.
Most people set up a trust as part of an overall estate plan, including creating a will and naming guardians. If you have minor children, then it probably makes sense to set up a trust. A trust holds property and money for beneficiaries such as your children. You spell out how these assets should be managed and used and appoint a trustee to oversee the process. If you are deceased, the trustee will manage and spend the money according to the rules you set for the trust.
Types of Trusts
Trusts can be either revocable or irrevocable. You can change, or even end, a revocable trust during your lifetime. You can’t undo an irrevocable trust. Unless you are very wealthy, a revocable trust probably is best. Wealthy people can use irrevocable trusts to protect their heirs from estate taxes — the taxes the federal government and some states charge on the property when transferred to heirs. Property in an irrevocable trust is generally not counted as part of an estate for tax purposes. If you have a disabled child, it can be smart to set up a special needs trust.
If you have a disabled child, you may want to set up a special needs trust. People with disabilities generally cannot have more than $2,000 of assets in their names and still qualify for government assistance programs. A special needs trust can hold assets, such as life insurance money, for your child, without disqualifying them from Medicaid, federal and state health insurance programs, or Supplemental Security Income through the Social Security Administration.
A life insurance broker can help you in choosing the right amount of life insurance. But you need an attorney to set up a trust. The key is for families to sit down with someone and discuss these issues thoroughly before committing them to paper. Once a plan is in writing, he says, it takes a lot of energy to go back and redo it. So, it’s best to get it right the first time.
The Uniform Transfers to Minors Act (UTMA)
You could set up a trust, but Instead of setting up a trust, you can name an adult custodian to manage your children’s inheritance under the Uniform Transfers to Minors Act (UTMA). The Uniform Transfers to Minors Act (UTMA) allows a minor to receive gifts—such as money, patents, royalties, real estate, and fine art—without the aid of a guardian or trustee.A UTMA account allows the gift giver or an appointed custodian to manage the minor’s account until the latter is of age. So, if you die while your kids are still young, the custodian will supervise the money until they reach legal adulthood — usually at 18 or 21, depending on your state. Then your kids will receive whatever cash is left.
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