Life Insurance Beneficiary: the Right Choice May Not Be Obvious

by Neal Frankle, CFP ®

Choosing the right life insurance beneficiary is considered straightforward. You bought life insurance to replace your income in case you die prematurely. Whoever relies on your income now is probably a good person to name as beneficiary. Right?

Well…not always. Sometimes this doesn’t work.

If you name your spouse as insurance beneficiary, the money will be subject to their creditors and the whims of his or her next spouse. Also, if you have a large estate, naming your spouse as life insurance beneficiary doesn’t leave room to do any estate planning. Finally, there’s always the possibility that your spouse may predecease you.

And there are other questions. What do you do if you have minor children? If you are happily married right now, that’s not a problem. Name your spouse. He’ll take care of the kids.

But what if you don’t trust your husband to be responsible with that money? What if you are divorced? Do you name your children the life insurance beneficiaries directly?

In a word, no. If you name your kids as the beneficiary of your life insurance, the insurance company can’t pay out to a minor. If you make no other provision, the companies might just hold on to the money until the kids reach 18, or the courts will have to get involved, which is a waste of time and a lot of money. It’s called probate and it’s very ugly. Something you should avoid if possible.

Other issues with this are that you may not want your 18-year-old to have access to all that money. I know I don’t. Even if she is responsible, she may not know enough to manage the money and to stay away from scammers.

You could name your estate as the beneficiary of your life insurance, but please don’t unless you love lawyers and judges and wasting time. Doing it this ways ensures your assets will go through probate, which is time consuming, money burning and just not smart as I said before.

If you find yourself in any of the situations above, consider setting up a revocable living trust and naming it as the life insurance beneficiary. If your situation is straightforward, use a service like LegalZoom.com to create your trust. It’s fast and inexpensive. When you set up the trust, you’ll name a trustee who will be responsible to dole out the money to your kids.

The benefit of naming a revocable living trust as your beneficiary is that it brings all the assets together, and this is really powerful. Let’s assume that your trust is the beneficiary of your assets and life insurance policies. Let’s keep going and assume you name your spouse as the beneficiary of your trust, but then you get divorced. In this case, you set up your own revocable living trust and name it as the beneficiary of your assets. By simply changing the beneficiary of your own living trust, you change the beneficiary of all your assets with one fell swoop. This is fast, efficient and complete.

You can also create an irrevocable life insurance trust to own the life insurance. This is usually done for estate-planning purposes, but it can also be a great way to make sure your beneficiaries are protected.

It’s also really important to keep in mind that the guardians of your kids don’t have to be the trustees of your trust. Using the example above, if you are divorced and you die, your husband will have sole custody of your children unless there are other circumstances. But just because he’ll have the kids, that doesn’t mean he has to have control over your children’s money. For example, if your mom is the best person you know to handle your kids’ money, name her. Who cares if your former husband doesn’t like her. That’s his problem.

Naming a life insurance beneficiary can be a complicated subject. I strongly suggest that you seek out qualified legal counsel before doing anything. Just the same, it’s nice to know what the issues you face are.

 

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