We hear of people all the time who decide to circumvent court interference by listing a trusted adult as the designated beneficiary of a life insurance policy. If you have minor children, they can’t receive money or assets of any kind until they reach the age of 18. Sometimes people think a good way around this is to leave the money to a trusted adult, who they know will care for the kids. The thinking goes something like this: “Bob is my brother; he and his wife Sarah are going to take our kids if anything happens to us, and we want them to have enough money to care for them. What could go wrong?”
Plenty of things can derail this kind of plan. What if that trusted adult passes away before you do, or even at the same time? It’s also possible that when the time comes, that trusted adult won’t be the one to care for your kids. People grow older, their health changes, their financial situation changes, and they move away. Unless you have signed an Appointment of Guardian or designated guardians in your Will, the courts have jurisdiction to decide who should care for your kids when you are gone. There’s no guarantee they’ll choose the trusted adult who you listed as the beneficiary of your life insurance policy. If they don’t, your family is in a situation where the guardian of the kids doesn’t have access to the money you left for their care.
Designated Beneficiary forms pass outside any Will or other estate planning document, and outside court supervision. Some people prefer this, believing that it will create an easy and secure path for their trusted adult to receive money to help them care for their kids. But passing outside any sort of oversight or governing authority means there’s no guarantee at all that the money will be used for the purpose you intend. No matter how trustworthy a person may be, all financial transactions should have some sort of oversight to ensure they are managed properly. To put it bluntly, there is nothing preventing that trusted adult from using the money for themselves. It isn’t even illegal because the money, by law, is theirs. Keep in mind that well-meaning and intelligent people were victims of pyramid schemes and investment fraud under Bernie Madoff. If your trusted adult loses the money (even through no fault of their own) your kids are the ones to suffer.
If the couple in this example created a trust for their kids and named Bob as Trustee, he could manage the money and distribute it in whatever manner the trust specifies. He could give them a lump sum of $75,000 to start a business, or pay for their college tuition, or buy them a car when they turn 16 (provided these are distributions admissible by the trust.) Bob gets to do this without any adverse tax consequences because he’s not using his own money. But if Bob receives $500,000 from a life insurance policy and gives $50,000 of it to his ward, that right there is a taxable gift. Bob needs to fill out a gift tax return for everything over $14,000 per year, and that total will count against his lifetime tax-free giving limit. At some point, he may need to pay gift tax on the money that he responsibly and generously used to take care of his nephews. Naturally, his brother wouldn’t have intended for that to happen. He just didn’t realize the consequences of his choice.
A Better Choice
There are much better ways to ensure that your life insurance benefits are used to care for your kids after you pass away. One method is to set up a Living Trust as the secondary beneficiary of your life insurance policy. Whatever assets are titled to the Trust will be managed by the Trustee you designate, outside of court interference, but protected by fiduciary duty and the rule of law. Another option is to allow the life insurance benefits to pass through your Will as part of your estate. It may take longer, but going through the probate process will ensure that your kids get the money they are entitled to receive. You won’t have to worry that an unexpected death or untrustworthy person will derail your plan.
There’s really no substitute for consulting with a professional. The stakes are pretty high when we’re talking about your assets and the legacy you leave your heirs. Let us craft a plan according to your specifications, and prevent unpleasant surprises. Give us a call.