Life insurance is a policy you buy to protect your loved one’s financial interests. No one likes to consider a reality in which they are not in their loved one’s life, but life is uncertain, and it could happen. To make the uncertain more palatable, many people purchase life insurance. Whether you have debts, you don’t want to saddle your loved ones with or family members who depend on your income to survive, life insurance gives you the peace of mind that they will be okay financially if something happens to you.
Equally important to purchasing the right life insurance policy to meet your needs is choosing your beneficiaries. This process may be more complicated than it appears at first glance. Many people feel confident that designating their spouse as their beneficiary and children as backup beneficiaries would take care of any potential scenario.
Regardless of your intentions, without certain protections in place, there is no guarantee that your beneficiary will actually receive or keep the benefit from your life insurance.
Who Can be Your Beneficiary?
When you purchase a life insurance policy, you can name a person or an entity as your beneficiary. Of course, you can name more than one.
For example, you can pass your money in your life insurance policy:
- To one person who will receive the entire policy, many people name their spouse as the beneficiary of their policy
- To two or more people who will split the money in the way you decide
- To your estate
- To a trust
- To a charity
Can A Minor Child Be My Beneficiary?
A Minor Child as Beneficiary Can Reduce the Life Insurance Benefits
You can name minor children as your beneficiaries, but be aware that most states require an adult guardian to manage assets given to minors. The process of appointing a guardian can be costly and lengthy.
James adopted a five-year-old boy named Raul when he lived overseas. James and Raul live in California in an expensive area of the state. James is a 3-D printer salesperson for an international corporation. He travels frequently. When Raul is not in school, they travel together. Otherwise, Raul stays behind with their live-in caregiver, Nancy.
James took out a $500,000 life insurance policy when he adopted Raul and named his son as the sole beneficiary. Unfortunately, James recently died in an automobile accident in Germany while traveling. Since Raul has no other family, the court has named Nancy as his guardian. Nancy has lived with Raul and James since Raul was adopted, and both consider her family.
Nancy manages Raul’s money carefully until he is legally an adult. Unfortunately, court costs, attorney’s fees, and guardian’s fees have made a significant dent in the life insurance benefits.
Guardians have limited investment options available, so the remaining funds in the life insurance policy have not kept pace with inflation. As a result, though the policy has helped pay Raul’s living expenses and education, there is not much left to pay for the college education James hoped to provide for Raul.
A Remarriage Can Complicate Inheritance
Jason and Mary have been married for fifteen years. They have three children under the age of ten. Jason is the sole wage-earner for the family. He has a $500,000 life insurance policy to provide for Mary and the children if anything happens to him.
Unfortunately, Jason is involved in a fatal motorcycle accident. The benefit from the life insurance policy is paid to Mary, just as Jason intended.
However, what happens next is not what he intended. Mary remarries. She and her new husband, Bob, have added each other’s names as joint owners on all their bank accounts. The bank account holding the $500,000 benefit from the life insurance is in one of these joint accounts. Mary has inadvertently left the entire death benefit to Bob as her beneficiary instead of her children. This scenario is not what Jason and Mary had planned for when they purchased the life insurance policy.
Naming a Trust as Your Beneficiary
One way to help ensure that your life insurance benefits go to the beneficiary you intended and save court costs is to name your trust as your beneficiary and then your loved ones as the beneficiaries of your trust. You may already be using a trust as an estate planning tool for leaving money and property to your loved ones. The same approach can be used to pass on the benefits of a life insurance policy.
Revocable Living Trust
If you have accounts and property that are valued below the current lifetime estate tax exemption amount or have already set up a revocable living trust, naming the revocable living trust as the beneficiary of your life insurance policy may be a great option. You would simply add the death benefits from the life insurance policy to the assets you already have in the trust. The trust agreement would instruct the trustee on how the benefits from the life insurance policy should be paid to the trust beneficiaries.
Irrevocable Life Insurance Trust
An irrevocable life insurance trust is different. It can both own the life insurance policy and be a beneficiary, which provides an extra layer of asset protection. You can either transfer ownership of an existing life insurance policy to your trust or purchase a new policy for the trust.
To pay the insurance premiums, simply use your annual gift tax exclusion to make cash gifts to the trust. Upon your death, the trust as your beneficiary receives the death benefits. The trustee will distribute the benefits to the beneficiaries as stipulated in the trust documents. Using this strategy, you can remove the value of the life insurance policy from your taxable estate.
Currently, the estate tax exemption is at a historic high. However, that can change with the new administration or sunset in 2026 at the latest. If you purchased life insurance to protect your loved ones, contact us to learn more about how trusts can provide an extra layer of protection for your loved one’s financial future.