I have needed to clear my conscience about something for some time. Up until the last few years, I have given clients with minor children poor advice with regards to how to set up beneficiaries of life insurance policies. My advice had always been to name your spouse first and, for a contingent/secondary beneficiary name the “estate.” This way, I explained, the Will would control with regards to how the insurance proceeds are to be dispersed to minor children.
This is the problem. If the estate is the beneficiary of life insurance, the proceeds are no longer “creditor free,” which is one the biggest benefits of life insurance (it passes to the intended beneficiaries free from any of your creditor claims). If the estate is the beneficiary of the life insurance, then the life insurance proceeds are added to the general estate. All of the general estate is subject to creditor claims. There are many ways in which there can be creditor claims against an estate 1) outstanding credit card bills; 2) medical bills arising from a long illness or lack of health insurance; 3) a suit or cause of action filed by a third-party; or 4) general hard times caused by lack of employment, to just give a few examples.
If the estate should not be the beneficiary of life insurance policies, who should the beneficiary be? Here are some options:
1. Name the person whom you presume would be the guardian of your minor children. This is a VERY BAD idea. By naming a third party to directly receive funds on behalf of your children, you are creating a moral obligation that the individual will actually apply the funds for the benefit of your children. Obviously, even if the individual told you now that he or she would do just that, such a promise is not enforceable. Also, that individual’s financial circumstances could be drastically different at the time of your death and he or she could be desperate enough to rationalize using the money to bail them out of the hardship. Another possibility is that the individual could be incompetent at the time of your death. That individual’s fiduciary (guardian or attorney-in-fact under a power of attorney) could have no idea of the prior moral agreement. Even if they did, their obligation would not be towards your children. On the other hand, even if the individual followed through by using the funds to provide for your children, that could create gift tax complications for him or her, should any of your child receive more than $13,000.00 from your named beneficiary. In short, this arrangement is a VERY BAD idea.
2. Name the minor children themselves as the beneficiaries. This is a BETTER idea. However, no insurance company will issue a check payable to a minor. Thus, someone will have to petition the court on behalf of the minor(s) for the appointment of a guardian to receive and administer the funds for the minor’s benefit. This process does not happen overnight and takes attorney fees to accomplish. In the meantime, the insurance company sits on the funds and the funds are not available for the support of the children. Also, when the child turns 18, the remaining insurance money is his or hers. Have you ever seen a lot of money in the hands of an 18 year old? It is generally a BAD idea. Thus, although it is BETTER to name your minor children as the beneficiaries of life insurance, it is not the BEST idea.
3. Name the Trustee of the testamentary sub-trust which you have created for your children’s benefit under your Last Will. This is the BEST idea. Washington law permits you to name as the beneficiary of your life insurance the trustee of any trust which you have created under your Last Will. Thus, if you have minor beneficiaries, I recommend that the beneficiary designation be changed as soon as possible to read similar to this:
“100 percent (100%) payable to Bill Smith, Trustee in the Last Will and Testament of the insured or his successor(s) in trust for the benefit of Catelyn Johnson and Aiden Johnson, minor children of the Insured.
LIFE INSURANCE PROCEEDS. My trustee shall collect the proceeds of any life insurance policy for which my trustee is the beneficiary, and shall hold those proceeds under the terms of this instrument. Payment to my trustee shall be a full discharge of the insurance company on account of the policy, and the insurance company shall not be responsible for the proper discharge of the trust. My trustee has no duty to begin collection proceedings or litigation to enforce payment of any life insurance policies until reasonable provision has been made to indemnify my trustee for all anticipated expenses and liabilities. Any proceeds of life insurance, retirement benefits, annuity payments or other benefits which are made payable to the Trustee named in this Will shall be allocated to the specific sub-trust indicated in the beneficiary designation, or if none, as if the proceeds or benefits had been a part of my estate at the time of my death.”
This trust is a “sub-trust” because it is created under your Will. It is a “testamentary trust” because it is created upon your death. By having the Trustee receive the money directly, the Trustee can immediately apply the money for the benefit of your children according to the directions you have provided to the Trustee in your Will. In your directions, you can also select how old your children will be when their trust comes to an end. In most cases, I recommend to clients that it be at the age of 25. This way the Trustee can make sure the children get through college and hopefully the children are much more mature than they were the age of 18.
In order to name the Trustee under your Will, you of course must first have a Will. A Will is absolutely essential especially if minor children are involved. I am happy to help with that process. Please do not hesitate to contact me if you have any questions regarding minor children and life insurance beneficiary designations or Wills.