Because we write a lot of life insurance for families with young children, this question comes up frequently. As you have purchased life insurance to protect your family’s financial future, it is important to ensure that your minor children are properly covered financially in the event of your death.
If you die when children are minors and you haven’t many any arrangements, as outlined below, there’s a good chance your kids won’t receive their portion of your policy’s death benefit. This is because:
- Most state laws require that a guardian be appointed to administer the proceeds payable to a minor.
- If a guardian isn’t in place at the time of your death, your next of kin will have to undergo the time and expense of appointing a guardian to receive and administer the proceeds.
- Once a court appoints a property guardian of the minor’s estate, that guardian will control the money for the minor’s benefit until he/she reaches the age of majority, depending on the state.
- If you are caring for a special needs child or adult, inherited funds from you or anyone else may put their government support in jeopardy. This could disrupt any care and support programs they depend upon for their daily care.
So, how do you ensure that your minor children will benefit from the proceeds of your life insurance policy in the event of your death? You need to arrange legal means for the proceeds of the policy to be managed and supervised by a competent adult because, if you don’t, the court will appoint a property guardian for the children. That process will run up attorneys’ fees, court proceedings, and court supervision of life insurance benefits — costs and hassles that definitely won’t help your children. There are several ways to prevent this:
- Instead of naming your minor children as beneficiaries of your policy, name a trusted adult beneficiary who will use the money for the children’s benefit. If you trust that this adult will always be able to fulfill this duty, even years down the line, this might be the easiest option.
- You can name your children as beneficiaries and also name an adult custodian under your state’s Uniform Transfers to Minors Act (UTMA). Most insurance companies permit this and have forms for it. If you name more than one child as beneficiary, you’ll need to specify the percentage each receives.
- If you have a living trust, you can name the trustee as the beneficiary of the life insurance policy. In the trust document, name the minor children as beneficiaries of any proceeds the trust receives from the insurance policy. Also, establish within the trust a method to impose adult management over the proceeds, which can be either a UTMA custodianship or a child’s trust. You’ll need to submit a copy of your living trust to the insurance company.
UTMA Custodianship vs. Child’s Trust
There are several key differences between leaving life insurance benefits to your children under the UTMA and through a child’s trust:
- Age when proceeds are released. In most states, a UTMA custodian must turn the proceeds over to the child at an age specified by law — 18 or 21 in most states, up to 25 in just a few. In contrast, with a child’s trust, you can specify any age at which your child receives the proceeds.
- Reporting requirements. A trustee for a child’s trust must file yearly income tax returns for the trust. A UTMA custodian need not file tax returns, although the minor must file a yearly return reporting money actually received.
- Tax rates. Trust income tax rates are higher than individual tax rates. Annual income above a certain amount in a child’s trust is taxed at the higher trust tax rates. In contrast, all of the property subject to the UTMA is taxed at the child’s individual tax rate.
- Ease of fulfilling property management duties. Because the UTMA is built into state law, financial institutions know about it and are comfortable with it. This should make it easy for the custodian to manage the insurance proceeds on behalf of the child.
Generally speaking, a UTMA custodianship is the most attractive option, unless the amount of insurance is very large and the child will need a property manager past the age of 21. The UTMA custodianship is simpler to set up and manage — and often cheaper (from a tax standpoint) — than a child’s trust. A UTMA custodianship is particularly sensible for proceeds below $100,000. Amounts of this size are often expended fairly rapidly for the child’s education and living needs, and are simply not large enough to tie up beyond the age of 21. If larger amounts are involved and you do not believe the child will be able to responsibly handle the money at the UTMA age limit, a child’s trust is a better bet.
About Richard Reich
In my 20+ years as an independent life and disability insurance broker, I have personally assisted thousands of clients with their life and disability insurance needs. As a national broker, I am licensed to write life and disability insurance in all 50 states and the District of Columbia.