Providing for Children Through Life Insurance & Related Legal Strategies
Some parents think of life insurance as a way to provide for their children if a parent dies unexpectedly. This option can be useful in some situations, but it is not always the right course of action. For example, parents who have accumulated substantial assets or who have wealthy family members might not want to pay life insurance premiums, since their children would have alternative sources of support. Many parents need to allocate a substantial percentage of their income to their children’s current needs, moreover, and these should be prioritized over life insurance. After all, the risk of dying prematurely is very low except in some unusual circumstances, such as when a parent is in the military or works in a dangerous occupation.
Certain types of life insurance will fit this goal better than others. Term insurance may make more sense than permanent insurance. Unless you are dealing with serious health issues, you should be able to cheaply purchase a term insurance policy. The insurance company will know that it has very little risk because you are unlikely to die before the term ends. On the other hand, you probably should avoid a policy that provides a lump sum payment at a distant time in the future or after you reach the age of 65. This will not provide any benefits to your children if you pass away in the near future. These policies also are very expensive and probably should not be integrated into your budget with your other family expenses.
Choosing Beneficiaries for the Policy
Your first thought might be to name your children as the beneficiaries of your policy, since they are supposed to receive the benefits from it. However, this may not be the best idea. If your children have not become adults when you die, the court will need to appoint a property guardian for them. The costs and inconvenience resulting from this procedure will undercut the assistance provided by the benefits.
The child (possibly with an adult custodian under the UTMA)
An adult trusted to manage the proceeds on the child’s behalf
The trustee of a living trust
If you trust another adult to manage the money from the policy on your children’s behalf, naming that adult as the beneficiary may be the simplest solution. Otherwise, you can name your children as the beneficiaries and name an adult custodian under the Uniform Transfers to Minors Act (UTMA). You can get a form from your insurance company to handle this process. Sometimes a parent wants to divide the proceeds of a policy among multiple children. They can provide the percentage that each child should receive on the form.
Another, more complex alternative is to name the trustee of a living trust as the beneficiary of the policy. You can then provide in the trust document that your children will receive payments made to the trust from the policy. You can use a UTMA custodianship to manage the proceeds of the policy, as above, or you can use a child’s trust. The insurance company will need to receive a copy of the trust document.
UTMA Custodianships and Child’s Trusts
A UTMA custodianship generally is a better strategy than a child’s trust. It tends to be cheaper, simpler, and more efficient. The custodian will not need to file tax returns, and the tax rate will be lower than in a child’s trust. However, the child will need to file an annual tax return that covers any money that they actually received. Managing a UTMA tends to be easier than managing a child’s trust because it is specifically set out under state law, so insurers and banks will be familiar with how it works. The child must receive the funds by the age of 18 or 21 in most states, and by 25 in others.
A situation in which a child’s trust may make sense is when a large amount of money is involved, and the child will not be able to start managing the funds at the age provided by state law. (Perhaps they have not shown much financial responsibility, or perhaps they have a disability.) However, the money in a UTMA or child’s trust often will be consumed before a child reaches 18 or 21 because their educational and living costs will accumulate quickly.