If you’re a parent who’s buying life insurance, you’re thinking about protecting your children’s future. So when it’s time to list a beneficiary for your policy, your first thought may be to name your child as the beneficiary.
But listing a minor as your beneficiary can actually do more harm than good. That’s because your child won’t be able to access those funds until they’re 18, and in the meantime it could get complicated.
Here’s how all that works, in addition to who you should list as the recipient of your policy’s death benefit, and how you can ensure that your children will have the financial support they need.
Life insurance is a contract between you and an insurance provider, where you agree to make payments (or premiums) each year in order to keep your coverage intact. If you pass away during your coverage period, the life insurance company will pay your beneficiary what’s called a death benefit.
The two most common types are term and whole life insurance. If you have term life insurance, you’ll only be covered for the years your policy is active, or your “term.” With whole life insurance, your coverage doesn’t expire and you can also build cash value over time. The death benefit can be used for things like:
Providing for your family
Paying off debts
Covering final expenses and burial costs
Serving a charity or cause you supported
In order for the beneficiary to receive the death benefit, they will need to file a claim with your insurance company and provide relevant documents if asked. That’s why it’s a problem to name minor children as your life insurance beneficiary: They are unable to do things like file claims, make bank deposits or own any assets.
“People don’t realize that when they list their young child (under age 18) as a beneficiary that the child won’t actually receive the proceeds from the policy directly, due to the Uniform Transfer to Minors Act,” says Wendy Terrill, a retirement planning counselor and founder of Assurance & Guarantee in Burlington, NC.
Instead, she says, the state will appoint a guardian. That person will “determine what’s best regarding how the child invests or spends the funds” until they reach adulthood. The court will usually look to appoint a relative or someone close to the family who will agree to act in the best interest of the minor if possible. This person will be your child’s legal guardian and responsible for raising them into adulthood and making financial decisions for them.
However, Terrill warns that a guardian chosen by the court may not agree with you when it comes to what’s best for your child or adhere to your wishes on what they should do with the life insurance money. “As the state-appointed guardian, this person will have sole discretion over how and where the funds will be invested or distributed.”
Another thing to consider if your child inherits your life insurance policy is the cost and time it takes for the state to appoint a guardian. Until that happens, the child can’t have access to the funds, Terrill says. “In addition, the child will not be receiving the full death benefit because of the costs and fees associated with the court.”
If you are married to the parent of your child, choosing a beneficiary might be fairly simple. Instead of leaving the money directly to your kid, you might leave it to your spouse, who can use it to care for the whole family—such as paying off a mortgage, funding higher education, daily living expenses and more. If you aren’t in a relationship with your child’s parent, you might still consider leaving funds to them. For example, if your ex-spouse would take care of your child if something happened to you, then you might still choose to leave some or all of your life insurance benefit to your ex, so they can look after your shared child.
If you insist on making your child the beneficiary for your life insurance policy, there are some effective ways to do this. To start, you’ll need to be as specific as possible.
You might be able to name multiple life insurance beneficiaries, so use this to your advantage. You might start by writing a will that appoints a legal guardian for your child, and then add this person to your life insurance as a beneficiary.
Let’s say you appointed your brother as your child’s guardian. If you were to pass away and your brother were listed as your beneficiary, then he’d receive your life insurance benefit. He theoretically could use that money for anything he wanted, but since he’s responsible for caring for your child in your absence the understanding would be that he would use the money to help care for your child. That said, legally, the money is his. Imagine if you were to pass away when your child was 17 years old. That’s still a minor, legally, so your brother would inherit your money. Would your brother necessarily relinquish the rest of the death benefit and hand it to your child once she turns 18?
To have a greater degree of control over where your money goes, you could create a trust. “The best way to avoid guardianship and/or spending issues regarding your life insurance benefit is to name a testamentary trust as the beneficiary,” says Drew Kavanaugh, a Certified Financial Planner (CFP) and Vice President of Odyssey Group Wealth Advisors.
He says, “A trust will also be able to spell out exactly how the funds can be used and when the child receives them.” For example, you could specify at what age your child should be handed the reins and granted full control over the money. You could also specify how the money can be used, like whether it’s earmarked for education or something else.
Keep in mind that in this case, you must appoint the trust fund as the primary beneficiary on your life insurance policy as well so that everything matches up.
Ultimately, it’s not a good idea to name a minor as the beneficiary for your life insurance policy. While your main goal may be to protect and provide for them while you’re gone, doing this will have the opposite effect. You can simplify the insurance claim process and protect your loved ones by taking these necessary steps now.
Fabric exists to help young families master their money. Our articles abide by strict editorial standards.
Fabric by Gerber Life exists to help young families master their money. Our articles abide by strict editorial standards.
Information provided is general and educational in nature and is not intended to be, and should not be construed as, financial, legal, or tax advice. Laws of a specific state or laws relevant to a particular situation may affect the applicability, accuracy, or completeness of this information. Federal and state laws and regulations are complex and are subject to change. We make no warranties with regard to the information or results obtained by its use, and disclaim any liability arising out of your use of, or reliance on, the information.
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