Sometimes, seemingly minor oversights can have tremendous consequences. Take life insurance, for instance. Most of us tend to name our beneficiaries when we buy a policy…and then never give the matter another thought. That could be a mistake.
Example: One of the biggest mistakes is naming a minor as beneficiary. On the surface, it makes sense to designate your children as beneficiaries, especially since you are buying the coverage to protect them. However, if you die while they are minors, a number of legal complications will ensue.
For their own sakes, minors cannot receive or control proceeds. In Pennsylvania, at age 18, a minor becomes emancipated.
Here are two typical scenarios that can lead to problems:
A couple names each other as primary beneficiaries and their minor children as secondary beneficiaries. However, what if both parents die simultaneously, perhaps in an accident, leaving toddlers as beneficiaries to a large sum of money?
In this situation, where both parents die simultaneously, the stage is set for complications. The court, perhaps without regard for the parents’ wishes, may appoint a stranger as guardian. Or, if a close relative is selected, this individual may have very limited input regarding how the funds can be used.
If both spouses work or there are step-families, a parent may decide to name only the minor children as beneficiaries. What would happen to the surviving spouse if the insured died?
In this scenario, with the children named as beneficiaries and one spouse excluded, the surviving spouse’s financial needs could remain unmet, while a large sum of money is set aside for distribution at the children’s 18th birthday. As a result, the surviving spouse could be disinherited, while minor children are heirs to a fortune.
In both instances, the final outcome would bear no resemblance to what the insured may have thought were his or her simple and clear intentions. It could also result in financial hardship for one or more people, often intended heirs, as well as legal wrangling that could go on for years.
Beneficiary Nightmare: A True Story
Jack had a large insurance policy on his life. Without giving it much thought he named his wife, Carol, and three minor daughters as equal beneficiaries to share and share like.
When Jack died in a car accident, his wife received $250,000, enough to pay final expenses and pay off the mortgage on their home. An additional $750,000 was set aside for their daughters. Carol was named guardian. However, the court restricted distributions. She struggled for years trying to make ends meet. When the daughters turned 18, each received her share – $250,000 plus earnings – without restrictions. The result was a nightmare of squandering of assets during minority and bickering that tore the remainder of the family apart.
The life insurance that was intended to help the family at Jack’s death became a curse that made things difficult.
Fortunately, this mistake can be easily corrected. If a spouse is present, his or her needs should be addressed directly, either as named beneficiary or with a separate life insurance policy that names the spouse as beneficiary.
The Use of Trusts
When minor children are involved, a trust can be set up to receive the life insurance proceeds. The advantage is that the parent establishes the trust, selects the trustee, and establishes the terms under which assets can be used and distributed from the trust. In this way, the life insurance proceeds can be used in the manner specifically selected by the insured. This works in the best interests of the minor children and those of other dependents, such as a surviving spouse.
So, think twice before naming minors as beneficiaries of your life insurance. Talk to your attorney for the best strategy involving your own situation, especially pertaining to the use of trust arrangements. Then meet with your financial agent to (1) discuss any changes needed regarding your existing policies and (2) make sure you have adequate coverage to protect all your loved ones.
Important: It is not sufficient simply to indicate in your will that your beneficiary should be changed. If your will names one beneficiary and the policy indicates another the policy designation will govern.