Intent #1: To have enough money, left all in one common pot, if possible (when there is more than one child), to be used to benefit and raise the children according to their needs.

Beneficiary Designation (A): With a properly made trust as beneficiary, the proceeds don't need to be split up into separate accounts for each of your minor children (that can be done later when they grow up). This allows your trustee to have the same freedom that you have now. He or she can access each child's needs and spend accordingly to benefit and raise them.

Trusts have many legal rules and regulations and the trustee is obligated to follow them and make a regular accounting to the beneficiaries. If the trustee does not behave accordingly, he can be brought before the court to be ordered to comply or be removed from trusteeship. Otherwise, if there is no complaint, the court does not get involved in any supervision.

The downside to a trust is that it can cost many hundreds to over a thousand dollars, depending on the complexity desired and what a given trust attorney decides to charge for his services.

If you can afford it, it may be well worth it, providing it's done by an attorney who actually specializes in estate planning.

The degree of freedom the trust grants to your (successor) trustee to manage the life insurance proceeds actually depends on the degree of freedom that you and the attorney design into your trust.

The degree of safety risk that your life insurance proceeds paid into the trust will face, also in part depends on what freedom and/or instructions you and the attorney design into the trust. By law, the trustee is not supposed to subject the overall portfolio of money to very much risk. Other risks involve whether the trustee will really follow your instructions, trust provisions, and the law or whether he will misappropriate the money. One of the ideas for having a trust is to avoid court procedures and give some flexibility to the trustee, but it may be possible for you to have the trust require someone else to check up on the trustee and review the accounting the trustee gives to the beneficiaries from time to time.

If you believe your trustee will be honest, but you are still unsure of their ability to manage or invest a large sum of money, you could designate that a trust company (usually a department of a bank) be the investment manager of the money. A trust company would charge for those services. An example of the charge would be a 1% annual fee of the fair market value of the account or $2,500 annually, whichever is more. If you are interested in this, then you may want to account for it in figuring out how much life insurance you need. You would simply lower your expected rate of return by 1%. (See "How much life insurance do I need? -- Calculator.")

If you want additional safety, besides naming the trust company as investment manager, you could also name them as co-trustee. In that case, monthly expenditures would have to be agreed on by your personal adult trustee, and the bank. That would cost more, and be more burdensome, but would keep the money safer from overspending, etc.

A trust does not provide the maximum freedom, since it does have rules and regulations, plus the instructions you and the attorney design into it, but it can provide enough freedom to clearly carry out Intent #1! Neither does it provide the maximum legal protection of constant required court supervision. Many people, however, have enough faith in their choice of trustee under the circumstances of knowing that he is subject to rules and has clear legal instructions to follow, that they are willing to take the risk (that the trustee could run off with money or make a bad investment), in order to have a vehicle that seems well-suited to carry out their intent. If not, then as previously mentioned, they minimize that risk by having a trust company manage the money, or even be the co-trustee.

You may also want to ask the attorney what the ongoing expenses and upkeep of a trust is presently, and what it will likely be for the trust when you die -- that may have an impact on the outcome and on your decision.

Beneficiary Designation (B): If you have more than one child, the only other way besides a trust to keep all the money together for their collective good in raising them is to name a trustworthy and capable adult as the beneficiary. This adult you choose might be the same person you would have chosen to be the trustee or the successor trustee (the trustee that takes over after you're gone) of your trust if you had set one up. Another presumption, and this is an important one, is that this would probably be the person that you (and your spouse-- if applicable) would nominate in your will as guardian. If not, it could get problematic. You would now have the money in the wrong hands. To get it in the right hands (assuming they would be honest and do that) would take gifting the money. Gifting large sums of money subjects the money to gift taxes. People can gift up to $10,000 each per year, to as many people as they want, free of gift taxes. Another option they would have, which is separate from the $10,000 per year, would be to use all or part of their allowable lump sum maximum lifetime gift exemption of $625,000 (which is projected to increase), but that's not too nice to want them to use that up for you.

Since under the arrangement there is no legal trust set up, there are no legal instructions as to how the money should be used. The only way to leave instructions would be to write a letter to the intended beneficiary (to be delivered only in the circumstance that you die and the proceeds are to be paid to that person). In that letter you could give instructions as to your intent. You would need to take great care in writing the letter, since it is easy to write instructions whose intent and meaning are perfectly obvious to the writer, but are unclear to the reader. You may want to ask an attorney about the implications of writing such a letter.

Many attorneys and estate planners feel that this is not a good method of making a beneficiary designation, and that it creates as many or more problems as solutions. Apparently many adults, even supposedly trusted relatives, have misused the money for their own advantage; ran off with the money; invested it poorly and lost much of it, etc. Most likely, in many of these non-trust situations, there was no letter of instruction. Of course, a letter of instruction just helps keep an honest person honest and lets them know your intent and how they should use and invest the money, but it doesn't ensure they will do it. For that matter, neither does a trust or some other methods; but the difference is that at least with a trust and some other methods, there are laws and legalities surrounding them and it is clear whose money it really is, and the legal action that can be taken against them is clear. That is not so with this method. Your letter of instruction, while having clear moral authority, might not have any legal authority. Again, you may want to ask your attorney about it.

It should be noted that one of the issues that some people point out as a problem in such a situation, may not actually be a problem. The complaint is that the adult sometimes uses some of the money for adding a room on to their house, or for buying a bigger house, with the excuse that it is for the benefit of the children. That is precisely whatIntent #2 is all about, and if you think that Intent #2 is a good and fair idea, then it should be made known that some of the money is earmarked for that purpose, so people won't think the children are being cheated. As far as the rest goes, the whole key is not just how capable and trustworthy the intended adult guardian is now, but how trustworthy and capable they really will be in the future, under the condition of complete freedom to use the money as they wish; since after all they were designated as the beneficiary, it can legally look like their money, with no rules to follow at all!

In short, this method of flat out designating a trusted adult as a surrogate beneficiary of your life insurance proceeds intended for raising your children has no up front cost, is easy to do, allows for the money to be kept together for greater flexibility and adaptability in raising the children, is free from court costs and lawyer fees and restrictions (at least at first); but also leaves the money more vulnerable than any other kind of beneficiary designation to several security and risk problems, including, but not limited to:

• The trusted adult not even being the one who gets appointed as guardian of your children and the tax and honesty problems that would then arise in getting the money in the right hands for your children's benefit.
• The trusted adult being naively influenced by a spouse (maybe not even the current one, but one they may marry later on) to use or invest the money inappropriately.
• The trusted adult dying and not having made a will or trust to make sure the money continues to be used for , or given to, your children.
• The trusted adult themselves falling into the temptation of misusing the money
• The money being subject to the creditors, liabilities, and lawsuit settlements against the trusted adult.
• The children having grown up by the time you die, but you forgot to change the beneficiary designation to be directly to them now, etc.

This method gives the highest amount of freedom, the least amount of rules and restrictions and supervision, and the least amount of legal safety.

Beneficiary Designation (C): This is the one that uses a form that only some life insurance companies provide. The form allows you to name your minor children as beneficiaries and yet designate and informal trustee of the child's money in case they are still a minor when you die; which allows the insurance company to pay out the money without needing the court to first appoint a guardian of the money.

In freedom and flexibility and safety risk, this kind of beneficiary designation has similarities to Beneficiary Designation (B), where a trustworthy adult is simply named as the beneficiary and is expected to use the life insurance proceeds for the benefit of the children. The difference being that in this case, there is an official paper trail showing to whom the money really belongs, and presumably the money would not be able to be pooled together. Also, when you die, if any of your children are adults, the form and trustee have no effect on that child's share, and your adult child receives his or her share directly.

The main freedom for the Intent #1 of raising the children that is compromised here is that the money is not supposed to be pooled together since the children are named, and share percentages are allocated to each one.

The risk taken is that since this method is free from supervision and is not hampered by many clearly defined rules, it leaves the money vulnerable to the informal trustee being naively influenced to use or invest the money unwisely; or the informal trustee giving in to the temptation of misusing the money or putting it in a bad investment; or the money being subject to creditors, liabilities, and lawsuit settlements against the informal trustee (if he puts the money in his own name instead of using an account set up on behalf of each child as he is supposed to do). If you are thinking of using this method, you may want to ask an attorney if it would be advisable to at least draft a letter of instructions to go along with everything.

Beneficiary Designation (D): For Intent #1 of raising the children, our understanding is that this would function about the same as (C), but some insurance companies could feel different and treat it more like (F), which would require court supervision. One would have to ask a specific life insurance company how they would handle it.

Beneficiary Designation (E): This one may function just like Beneficiary Designation (C), except that it is using a provision of state law to transfer the proceeds to a minor via a custodian, under the Uniform Transfers to Minors Act, and therefore it does have more legal rules and laws governing how it operates and how the custodian is to operate and what his obligations and duties are, regarding the child's money.

Still, just like (A), (B), (C), and (D), it does not require any court supervision, so there still is more safety risk in this method than there would be in a method that did require court supervision (see (F)). But if the custodian doesn't follow the rules, or is withholding money that the child, or the child's representative, or an adult family member of the child feels should be expended on his behalf, then the court can be petitioned to step in and enforce the obligations and rules that are clearly set forth. Of course, if the custodian is really a stinker, and has already blown all the money, and is personally bankrupt himself, then the court can't help bring the money back. But this method does have more safety features than (B), (C), or (D) does and still allows for a great deal of freedom, if that is what is desired.

If you would like even more safety, you could require the custodian to be bonded. There would be good safety because the surety bond company would be insuring your children's money against loss. It does come at a price. For example, if each child's share was $50,000, then each bond would cost about $260 annually. Or, if each child's share was $250,000, then each bond would cost about $1,000 annually.

The surety bond company would demand that the custodian personally have good credit, and that he keep good records. They may want him to pay many or all the years of bond premiums in advance (at least he would receive a discount). Obviously, the person you name as a custodian would have to stand up to close scrutiny.

He may have to pay those bond premiums out of his own pocket, but in turn he can charge for his services as a custodian-- if he so chooses. The money he charges would come out of your child's money. Even if he's not required to be bonded, he can still charge for his services. Whether bonded or not, if he does charge for his services he will be held more personally liable for how he manages your child's money.

At any rate, safety costs extra, but is very much worth considering. If you do decide to require the custodian to be bonded, you may want to throw in some extra life insurance under Intent #2 to be paid directly to the custodian (in his name only) so he will have the necessary money to pay for the surety bond.

The part of Intent #1 that would be frustrated is the ability to pool the money together, since Uniform Transfers to Minors law dictates that no other money may be mingled together with the money of a specific child.

Beneficiary Designation (F): Simply naming the minor children as beneficiaries will not allow the money to be put into one common pot. Each child will get an equal share (unless other percentages were assigned) put into a separate account that will be for that child and that child only. The money may or may not be able to be used to the extent desired to at least have each child's share respectfully used to raise him or her.

The reason is because minor children can't legally hold, manage, or dispose of any considerable amount of property or money on their own. An adult must be in charge and act on a child's behalf. Therefore, if minor children are simply named as beneficiaries of life insurance proceeds with no other provisions and the proceeds become payable while any child is still a minor, that child's share will not be paid out until a probate judge designates an adult guardian or custodian of the money. According to our understanding, that guardian will be under the supervision of the court to help assure that the money isn't misused. Fees will be charged and will be taken out of the child's money.

If the money is needed for raising the child, it will require a constant petition and approval and accounting before the court, separately, for each child. It keeps the money safe from misuse, but does so at a cost, due to the possible fees of the attorney, accountant, money manager, and the court.

Thus, this method keeps the money safer -- except for the fees -- and it costs nothing extra to make this designation; but it doesn't allow for a pooling of all your children's money and may restrict the guardian more than you had intended to, from using the money to spend on the children as you would do if you were there.

Also, if the share of each child isn't large enough, this may especially be a burdensome method. If the child's share is a substantially large amount, some people feel that the cost and burden are worth it for the safety received.

Licensed in:
Arizona, California (license #0629626), Oregon, Texas, and Virginia. For other states, inquiries are referred to agents licensed to handle insurance in that particular state.

PGA Financial has no intent to generate interest in any particular life insurance company or specific policy, but rather to inform and educate you on the general concept -- after which, if you are interested, a broker at PGA Financial will be glad to research companies that offer such plans, get you a quote and assist you in making a choice. If you do become interested and obtain a policy, the broker would be compensated by the insurance company.

© 1998 The PGA Financial Co. All rights reserved.