In the first part of this series, I discussed the first three of six questions you should ask yourself when selecting a life insurance beneficiary. Here I will cover the final half.
Selecting a beneficiary for your life insurance policy sounds pretty straightforward. But, given all of the options available and the potential for unforeseen problems, it can be a more complicated decision than you might imagine.
For instance, when purchasing a life insurance policy, your primary goal is most likely to make the named beneficiary’s life better or easier in some way in the aftermath of your death. However, unless you consider all of the unique circumstances involved with your choice, you might actually end up creating additional problems for your loved ones.
Last week, I discussed the first three of six questions you should ask yourself when choosing a life insurance beneficiary. Here I will cover the remaining three:
4. Are any of your beneficiaries minors?
While you are technically allowed to name a minor as the beneficiary of your life insurance policy, it is a bad idea to do so. Insurance carriers will not allow a minor child to receive the insurance benefits directly until they reach the age of majority—which can be as old as 21 depending on the state.
If you have a minor named as your beneficiary when you die, then the proceeds would be distributed to a court-appointed custodian tasked with managing the funds, often at a financial cost to your beneficiary. And this is true even if the minor has a living parent. This means that even the child’s other living birth parent would have to go to court to be appointed as custodian if he or she wanted to manage the funds. And, in some cases, that parent would not be able to be appointed (for example, if they have poor credit), and the court would appoint a paid fiduciary to hold the funds.
Rather than naming a minor child as beneficiary, it is better to first set up a trust for your child to receive the insurance proceeds. That way, you get to choose who would manage your child’s inheritance, and how and when the insurance proceeds would be used and distributed.
5. Would the money negatively affect a beneficiary?
When considering how your insurance funds might help a beneficiary in your absence, you also need to consider how it might potentially cause harm. This is particularly true in the case of young adults.
For example, think about what could go wrong if an 18-year old suddenly receives a large sum of money. At best, the 18-year old might blow through the money in a short period of time on clothes, jewelry, cars, or on their friends. At worst, getting all that money at once could lead to actual physical harm (even death), as could be the case for someone with substance-abuse issues. Now, these are worst case scenarios. However, we can probably agree that no 18-year old is prepared to manage a windfall of cash in their pocket!
To help mitigate these potential complications, some life insurance companies allow your death benefit to be paid out in installments over a period of time, giving you some control over when your beneficiary receives the money.
However, as discussed earlier, if you set up a trust to receive the insurance payment, you would have total control over the conditions that must be met for proceeds to be used or distributed. For example, you could build the trust so that the insurance proceeds would be kept in trust for beneficiary’s use inside the trust, yet still keep the funds totally protected from future creditors, lawsuits, and/or divorce.
6. Is the beneficiary eligible for government benefits?
Considering how your life insurance money might negatively affect a beneficiary is absolutely critical when it comes to those with special needs. If you leave the money directly to someone with special needs, an insurance payout could disqualify your beneficiary from receiving government benefits.
Under federal law, if someone with special needs receives a gift or inheritance of more than $2,000, they can be disqualified for Supplemental Security Income and Medicaid. Since life insurance proceeds are considered inheritance under the law, an individual with special needs should never be named as beneficiary.
To avoid disqualifying an individual with special needs from receiving government benefits, you should first create a “special needs” trust to receive the proceeds. That way, the money will not go directly to the beneficiary upon your death, and instead it will be managed by the trustee you name and dispersed per the trust’s terms without affecting benefit eligibility.
The rules governing special needs trusts are quite complicated and can vary greatly from state to state, so if you have a child or family member who has special needs, meet with me to ensure you have the proper planning in place, not just for your insurance proceeds, but for the lifetime of care your child may need.
Make sure you have considered all potential circumstances
These are just a few of the questions you should consider when choosing a life insurance beneficiary. Consult with me as your Personal Family Lawyer® to be certain you have thought through all possible circumstances.
And if you think you may need to create a trust—special needs or otherwise—to receive the proceeds of your life insurance, meet with me, so I can properly review all of your assets and consider how to best leave behind what you have in a way that will create the most benefit—and the least challenges—for the people you love. Schedule your Family Wealth Planning Session today!