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Should minor children be named as primary, or even secondary beneficiaries of life insurance proceeds?

Few people understand the consequences of the specific way they have the life insurance proceeds set up to be paid out on their children's behalf. The important thing to do is examine what your intent is and then choose the type of beneficiary designation that has the best chance of following your intent. Often it is not even thought through what a person's intent is, or maybe more importantly, what their intent would be if they were given some options and really thought about which options they like. Let us look at what kinds of intent people have and then we'll look at the different ways people might make a beneficiary designation that will pay out the money on their children's behalf as close as possible to their intent, given the possible consequences.

First, click on the option that applies to you:

Married couple with minor children
Single parent with minor children

For a married couple who has minor children, the spouse is most often named as the primary beneficiary. Why do they do that? Usually because their first intent is not concerned with the proceeds as a future inheritance for the children when they reach adulthood, but rather as money to help the family continue in their lifestyle as best as possible, in case one of the spouses die prematurely, and to provide money to be set aside for the spouse's retirement, and possibly for the children's college fund. So it can be said that the money is intended for the benefit of the spouse to raise the children as was intended and maybe also take care of the spouse when the children are gone.

The couple also realizes that they could be out on a date (with each other) and die together in an accident. So they need to name a secondary beneficiary(ies). What would their intent be for the proceeds of their life insurance if they are both gone? Obviously, if they thought about it, their first intent would probably be that the proceeds are used to raise the children. Of secondary importance is leaving an inheritance that the children will take hold of and be personally responsible for when they reach adulthood.

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For a single parent who has minor children, the children themselves are often named as the primary beneficiaries. Why does the parent do that? So the children won't be left penniless and destitute! If the parent thought about it, what would really be of primary importance? Would it not be that the life insurance proceeds are used to raise the children, and then of secondary importance, that there be an inheritance for them when they reach adulthood?

"Using the (or some of the) life insurance proceeds to raise the children" can mean different things to different people, so let's categorize some different ways the money could be used:

  • Money that only benefits the children - Basic needs: food, clothing, education, etc.
  • Entertainment, vacations, trips, toys, gadgets.
  • Money that is spent to benefit the children, but also may enrich the guardian or parent of the child (depending on who holds ownership).
  • The guardian/parent may need a bigger car, a new, bigger home, or a room add-on to the existing house in order to accommodate your children.

Now that you've read and thought about the different ways your life insurance proceeds could be used to raise your children, would you want the money to be used in any and all of those categories? If not, what would you place limitations on if you could have it your way?

Do you think it would be so bad to take some of your life insurance proceeds and allow them to be used to benefit both your children and your intended guardian of your children should you (and your spouse, if applicable) pass away?

Sure, it might take away some of the money that could ultimately be an inheritance for your children, but if that guardian takes the burden (hopefully accompanied by some joy) of raising your children and makes a sincere effort, don't they deserve a reward? It might also mean less money for the lawyers and judges, but they will probably still be okay.

There is another issue that needs to be dealt with regarding using the money to raise the children as a first priority, with leaving the money as an inheritance being of secondary importance. Perhaps the best way to introduce this issue to you is to describe it as a situation that you can imagine might happen to someone, followed by a reaction to the situation that you probably would not have imagined. Suppose there is this family with three children and the littlest one, by the name of Ashley, comes down with a disease and needs some special care and treatment. The parent could scrape up the money to pay for the special care and treatment but.... Now imagine that this is what follows the "but": "It has always been the intent that the children share equally. If the necessary amount of money is paid out for the special care and treatment of little Ashley it will take up more than her fair share of the money, and the other two children will get cheated out of their future inheritance. It's too bad that Ashley can't have her special care and treatment, but it just wouldn't be fair to the other two."

How many parents would really think that way? Surely none would purposely wish to do that! They treat the children as equally as possible, but realize that the children may have different needs that can carry different costs. (Children always think everything is no fair anyway.)

So it's probably fair to say that if it can be avoided, and they can afford to do it, nobody would intentionally wish their life insurance proceeds to be handled in such a cold way, either. Unfortunately, some ways of making beneficiary designations have rigid consequences that allow for no flexibility in such situations, and those in charge of the proceeds are compelled by law to do what was probably not the parent's original intention. There are ways to avoid such inflexibility and they will be discussed further in the section on actual beneficiary designations.

Another issue to consider is how many eighteen-year-olds are great at handling a large sum of money that is unconditionally left to them? Just put the word expensive in front of words such as "fully loaded automobile, TV, stereo, recreational vehicles, clothes, jewelry, trips, music collection, gifts, favors, etc.", and you'll probably have a list of where the money went. It is probably safe to say that if it wasn't too difficult to avoid, most people would rather not have a large sum of money handed over to an eighteen-year-old. The issue is not just about wasting money, but also about affecting a child's character. So another intent to consider is if there is to be an inheritance for your child's adult life, how and when should it be left to them?

Finally, one last issue of intent concerns not so much what is for the benefit of your children, but what lump sum amounts will be needed to meet final expenses (burial, funeral, etc.), bills, liabilities, and obligations that you leave behind. Presumably, you want those to be paid for. So some of the proceeds need to be earmarked for those things.

To summarize, there are four basic areas and ways most people might want to consider having their life insurance proceeds divided among, in a situation where their children are still young.

  • 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.
  • Intent #2:To have some other money that is earmarked for the benefit of the children and their guardian to buy whatever additional vehicles or housing, etc. is necessary to accommodate their new situation.
  • Intent #3:If the money (or some of it) is not needed to raise the children, let it be held for them in the most cost effective and prudent way possible, and/or that it be given to them as an inheritance for their adult life in as responsible a way as is feasible.
  • Intent #4:That there be some money immediately available for your funeral, burial, and other expenses and obligations you will leave behind.
  • Now follows a list of the kinds of beneficiary designations that people with minor children have used, in some cases not realizing the consequences.

    • Beneficiary Designation (A): A trust is named as the beneficiary (the trust would need to be set up of course).
    • Beneficiary Designation (B): A trustworthy adult is simply named as the beneficiary, whom you expect to use the life insurance proceeds for the benefit of the children or whatever other purpose you may have wanted.
    • Beneficiary Designation (C): The minor children are named as beneficiaries with a provision that if any are still a minor when the proceeds are to be paid out then that child's share will paid out on their behalf to a trustworthy adult who is designated as an informal trustee by using a special form provided by the life insurance company (not all companies have such a form).
    • Beneficiary Designation (D): The minor children are named as beneficiaries with a provision that if any are still a minor when the proceeds become payable, then that child's share should be paid to a trustworthy adult you name "for the benefit of" such child.
    • Beneficiary Designation (E): The minor children are named as beneficiaries with a provision that if any are still a minor when the proceeds are to be paid out, then that child's share is to be paid out on their behalf to a trustworthy adult who is designated as a custodian of the child's share under the Uniform Transfers to Minors Act (UTMA) of their state (most states have adopted the UTMA, including California, Arizona, and Virginia).
    • Beneficiary Designation (F): The minor children are simply named as the beneficiaries.

    When looking at how any of these beneficiary designations will affect your intent for your life insurance proceeds, it would be helpful to keep in mind the two key factors that will come into play. They are freedom and risk. They naturally follow each other, and might affect the safety of those proceeds or the ability to use them.

    If you seek to give the highest degree of freedom over the proceeds so the guardian of your children won't be the least bit hampered (by rules and regulations and the court) in using the proceeds as you want them to be used, then you will have to accept a higher risk that the money could be misused or wasted. If you seek the utmost legal protection and supervision of the proceeds from loss due to ineptness, misuse, liabilities, or dishonesty, then you will have to accept that the guardian of the children might not have much freedom to carry out your wishes (depending on what your wishes are); and/or he might be burdened with extra legal duties and costs.

    Different beneficiary designations will have different balances, but none will allow for the absolute highest degree of both freedom and legal protection so you'll have to decide to what extent you would be willing to compromise in either area in hopes that it will create the best opportunity for your intent to be carried out.

    There is a price for safety and sometimes that price is very worth it and sometimes it is too high. Imagine that you set it up so that if you die, the court will have to supervise the money and maybe the money will have to be managed by a professional custodial money manager. What if the annual fees for all this supervision come to 2% or 3% annually of the child's total share of money or $6,000 annually, whichever is more. If your life insurance proceeds are $200,000 and you have three children, each child's share would be about $66,000. If a child's share of $66,000 earns an investment return of 8%, that would be $5,280. That means the fees of $6,000 would take all of the profit, plus some of the principal! The so called safe money would be gone sooner than you would have expected. Now if you had $750,000 of life insurance coverage and each child's share was $250,000, it would be a different story. A return of 8% would be $20,000. Fees would be $7,500, so there would still be a net return of $12,500. That's at least a bit more reasonable.

    So when you are choosing a type of beneficiary designation with minor children involved, you may also want to keep in mind the practicality and expense of administration that a method will have, versus the amount of your life insurance proceeds and how much each child's share would be if the method does split up the proceeds.

    Now let's go over the four basic areas of intent, one at a time, and look at some of the ways that those beneficiary designations can be made, and to the best of our understanding, what consequences a specific designation will have on your intent and what it might compromise in the areas of freedom or safety. Also, remember that these situations, intents, and beneficiary designations may, in some cases, apply only to the secondary (contingent) beneficiaries, because if you're married, you may have your spouse as the primary beneficiary.

    At this point, if you want to skip the detailed explanation and go to the Summary Matrix, then click here. If you want the details, continue on and click on one of the four "Intents".

    Intent #1 Intent #2 Intent #3 Intent #4

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