Choosing Wisely: Naming Your Trust as Beneficiary of Your Life Insurance
Introduction
Most people buy life insurance to provide assets to their loved ones upon their death. This becomes especially important when you have young children. Most people, wealthy or not, don’t have sufficient liquidity to maintain the current lifestyle for their children if they were to pass away. The simple solution in most cases is term life insurance. It is cheap relative to the potential death benefit and therefore is often the first type of life insurance people will buy. Ask any life insurance salesperson and they will give you 100 other reasons to purchase life insurance. However, regardless of which type of life insurance you buy, or the reason for buying it, you should always name a beneficiary.
Most life insurance policies have default beneficiaries if you do not specifically choose beneficiaries. It seems odd that someone would purchase life insurance and not specifically name a beneficiary, but it does happen. Most default life insurance beneficiaries are the insured’s estate. Essentially this means the life insurance policy will go through Probate and distributed to the insured’s heirs-at-law.
Naming Minor Children as Beneficiaries
For those that name a beneficiary, the most common beneficiary structure is the insured’s spouse and then children. The problem is you should never name a minor as a beneficiary of any asset. If you take anything from this article, remember that. Why should you never name a minor child as a beneficiary of your life insurance policy? Because they will not have access to it until they are 18 years of age. Instead, it will be supervised by the probate court until the child is 18 years of age. And once they are 18, they will have full control to spend it however they want.
Side note: If you are a life insurance agent or financial advisor reading this, this should set off alarm bells and you should discuss this issue with your clients and refer them to your favorite estate planning attorney!
Despite this horrible result, more than 90% of the life insurance policies out there name minor children as beneficiaries.
Naming Your Revocable Trust as Beneficiary of Your Life Insurance Policy
There is a much better option. Enter the revocable living trust. We have many articles about revocable trusts, but put quite simply, a revocable trust is an agreement between you and some future trustee regarding the division and distribution of assets (in this case, life insurance proceeds). This agreement can be amended at any point during your lifetime.
Benefits of Naming Your Trust as Beneficiary
- Avoid Probate
As already discussed, without a Trust, your life insurance proceeds will be distributed and supervised by the Probate Court until your minor children are 18. This is both costly and time-consuming.
- Control and Protection
One of the primary benefits of naming your trust as the beneficiary of your life insurance is control. By creating a trust, you can specify how the life insurance proceeds should be distributed to your beneficiaries. This control is especially valuable if you have concerns about the financial responsibility or maturity of certain beneficiaries.
- Privacy
When a trust is named as the beneficiary, the distribution of the life insurance proceeds remains private and does not go through probate. This means that the details of the policy, its value, and the distribution plan are not subject to public scrutiny.
- Asset Protection
Depending on the type of trust you create, you may be able to protect the life insurance proceeds from creditors, lawsuits, divorces or other financial setbacks that your beneficiaries may face in the future. This added layer of asset protection can be invaluable in preserving your legacy.
- Estate Planning Efficiency
Naming your trust as beneficiary can streamline your estate planning process. It allows for the integration of your life insurance policy into your overall estate plan, ensuring that the proceeds are distributed in accordance with your wishes and estate planning objectives.
Considerations and Caveats
While naming a trust as the beneficiary of your life insurance policy offers several advantages, it’s essential to consider some key factors:
- Consult an Attorney
Creating a trust and designating it as the beneficiary of your life insurance policy is a legal process that requires careful consideration and professional guidance. Consult with an experienced estate planning attorney and your financial advisor to ensure that your trust aligns with your goals and meets all legal requirements.
- Trust Administration
Naming a trust as the beneficiary adds an extra layer of complexity to the distribution process. The trustee will be responsible for managing and distributing the life insurance proceeds according to the trust’s terms. Choose a trustee who is knowledgeable and trustworthy.
- Tax Implications
Different types of trusts have varying tax implications. Consult with a tax advisor to understand how naming a trust as beneficiary might affect the tax treatment of the life insurance proceeds and the overall impact on your estate.
- Review and Update
As with any estate planning strategy, it’s essential to periodically review and update your trust and beneficiary designations to ensure they align with your current financial situation, family dynamics, and objectives.
Conclusion
Naming your trust as the beneficiary of your life insurance policy can be a smart and strategic move in your estate planning efforts. It provides you with probate avoidance, control, protection, and privacy while helping streamline the distribution of assets to your loved ones. However, it’s crucial to seek professional advice to navigate the legal and tax complexities involved. With careful planning and the right guidance, you can make a decision that aligns with your long-term financial goals and provides lasting security for your beneficiaries.
John Wong advises on all aspects of estate planning, probate, asset protection and trust administration. He believes that estate planning is about planning for life; while having protections in place should the unexpected occur.
