Why setting up a life insurance trust for your child is better than naming them as your beneficiary — especially if they're a minor
For parents, the safety and well-being of their children is paramount — and most people get life insurance to cover the mortgage, education, and other expenses so that their family can continue after they die.
While your intentions might be good, naming a minor as a life insurance beneficiary can cause significant complications because life insurance policies can't be disbursed to minors. Instead, it is better to establish a trust for your child and name the trust as the beneficiary of your life insurance.
Trusts aren't just for the wealthy. They're but a great estate planning tool to transfer property, stocks, and life insurance proceeds. Trusts also help avoid probate problems.
As noted by AAA Life Insurance, "Minor children cannot directly receive the proceeds of a life insurance policy. Instead, the state would appoint a legal guardian if you hadn't done so, which is a lengthy and costly process. That guardian would then determine how the money is managed and spent — and it may not coincide with your wishes."
If you are a single parent, consider whether you'd want the non-custodial parent named the court appointed guardian of the life insurance funds for your child. What if you're divorced? Do you want a stepparent to be appointed your child's guardian? I have seen relatives come out of the woodwork and volunteer to be guardians when money is involved.
Having a trust avoids this problem because the trust dictates how the trustee will administer assets for your child's benefit, including whether money should be given to the guardian.
According to New York Life, "A trust is a more detailed arrangement and provides increased control over how assets can be used. For example, a trust can be established to receive and manage the life insurance proceeds on behalf of minor children or adult family members with special needs. In this situation, the trust is designated the beneficiary of the life insurance proceeds."
Most people who establish a trust for their children do not have their children receive full control until they are 25 years old. A trust can have the trustee pay for your child's education and living expenses. You can have the trustee pay a monthly stipend to the guardian. You can have the trust administer a monthly allowance to your child when they become an adult instead of giving full access to the trust funds. The beauty is that you control how the assets are administered.
The disadvantage to a trust is that it is more expensive to set up because you will need to hire an estates attorney. The price to establish a trust varies according to your estates attorney's legal fees. However, expect to pay $1,600 to $2,000.
Although setting up a trust is more expensive, it gives you more control over how the funds are spent and when your child gets access to the funds. Because you can select a bank or money manager as the trustee, there are additional safeguards in place to guard against misuse of funds.
Here are the steps you'll need to take to establish a life insurance trust for your children. You will need a lawyer that specializes in estate planning to draft your trust.
The benefit of a trust is that you can be as detailed as you want. Barbara Pietrangelo, a certified financial planner, told Business Insider that you should "consider HEMS — health, education, maintenance, and support" — when setting up a trust for a child. Pietrangelo also noted that a trust is flexible; you can make updates to it as your wishes or circumstances change.
Pietrangelo said that she and her husband established separate trusts for each of their children outlining their wishes and creating limits. For example, the trust had a stipulation that if the children received bad grades in college, funding would be withdrawn. The trust also stated that it would provide matching funds when the child wanted to buy their first home. Another stipulation was that the trust would pay for the child's first wedding but not a second. She said the trust also included funds for extracurricular activities, reading literacy, and tutoring if children needed extra support.
Pietrangelo noted that a trust is better than a UTMA account because UTMA distributes funds as soon as the child becomes an adult — which can be at 18 or 21 years old depending on your state. As Pietrangelo noted, most 18 and 21 year-olds do not have the maturity to manage a lump sum financial gift.
Pietrangelo recommends that parents establish healthcare directives for their children, not only in case the parents die but also for normal events. Pietrangelo said parents should write up a form, a sort of fill-in blank medical release, so if parents are traveling without the kids, the grandparents or babysitter can help get medical care for the child. She noted this is useful in instances of divorce when questions arise regarding who makes decisions for a child if injured.
Pietrangelo said that special needs dependents can't have money in their name or the money goes to the government. "If you have a special needs child or adult you care for, inherited funds from you or anyone else may put their government support in jeopardy. This may disrupt the care and support programs they depend upon for their daily and future care," according to New York Life.
Pietrangelo noted that a "special needs trust" is necessary in this situation. A special needs trust is different from a regular children's trust because a special needs dependent typically needs care for their entire life and likely isn't going to be independent.
"The hardest part of establishing a trust is picking the trustee," said Pietrangelo said. The trustee can be a person, bank, or financial institution, a sibling, or an outside party. Some parents name themselves as the trustee and select a backup trustee when they die.
Pietrangelo noted that you want to pick someone good with accounting and finances because there is a lot of paperwork involved with being a trustee. Some people select their bank, law firm, or accountant as trustees, but note that a financial advisor can't be a trustee.
Pietrangelo cautioned that "if you want your family to be able to have peaceful holiday dinners, it may be better to have an outside trustee who is a neutral party." She noted this way siblings can be mad at the trustee and not a relative.
Ideally, you should have a will in addition to your trust. The will should outline who will take care of your child should you die. This person is known as the guardian. The guardian is responsible for the day to day care of your child.
Sometimes, a guardian is good with your kid, but not good with money management. Pietrangelo said, "Guardians care for the children, not the finances." The guardian does not have to be the trustee of the trust.
Pietrangelo said that you should review your trust documents yearly. The beauty of a trust is that you can make changes to it. If your child develops a disability or there are other stipulations you want to add based on your child's behavior, the trust allows you that flexibility.
If you are concerned about providing for your child in case something happens to you, it is better to establish a trust for your child and make the trust the beneficiary of your life insurance policy.
The contents in this article are being provided for educational and informational purposes only. The information and comments are not the views or opinions of Union Bank, its subsidiaries or affiliates.