The choices you make when choosing your life insurance beneficiary can have disastrous consequences down the line. Here are three mistakes I’ve seen as an estate planning attorney.
1. It’s not your Will that determines who gets the life insurance money –it’s the beneficiary designation of your policy.
If your Will says that your son Bob should get everything, but your life insurance policy names your brother Fred as beneficiary, then Fred is getting the money. So remember this rule: beneficiary designation trumps Last Will and Testament.
It is important to confirm that your life insurance beneficiaries reflect your wishes.
2. Listing minor children as beneficiaries of your life insurance policy (e.g., primary= spouse; contingent=children)
My wife and I love our two kids, Adina (16) & Corey (12), very much. But we do not want them getting control of the life insurance death benefit when they turn 18. Why? Because they’ll be only 18! College or car? Unfortunately, when life insurance is left outright to minor children, they get full control and use of it when they turn 18. Most want their inheritance to last a long time (10 years, 20 years, a lifetime). The average inheritance is gone within only 17 months. It’s not hard to see why.
In addition, the law does not allow minors to control their own money. Instead, it requires a Conservatorship—where the court ultimately oversees the child’s assets until they turn 18. This process is very expensive and cumbersome, and some life insurance companies do not even permit listing a minor child as a beneficiary.
How can you avoid this issue? Please read on.
3. Listing a sibling or friend, rather than children, as beneficiary to avoid the problems in #2 above.
A friend of mine was the middle of three minor children when his parents divorced. His mother had a life insurance policy to protect the children in case something happened to her. She didn’t want to list the minor children as beneficiaries because of the problems discussed above, so she listed her sister instead. The mother died when the youngest child had just turned 18. Instead of using the life insurance death benefit for the children, who had no way to pay the house mortgage, the sister decided to keep the money. The children had no recourse and could not convince her otherwise. Ironically, the sister died a year later, but then the proceeds passed to her children.
Leaving the life insurance death benefit to a sibling or friend assuming they will take care of your children carries much risk. The beneficiary is under no obligation to carry out your wishes and share the death benefit with your children. Even if the beneficiary has the best of intentions, there’s still risk. If the beneficiary goes through their own divorce after receiving the inheritance, depending on state law, there’s a decent chance the beneficiary’s soon-to-be ex-spouse might receive half the life insurance death benefit meant for your children in the divorce settlement.
If you want to leave the life insurance death benefit to minor children (either as primary or contingent beneficiary), the best solution, by far, is to leave it in trust for their benefit. You avoid the expensive and cumbersome Conservatorship, you protect the death benefit from their immaturity, and you can even protect it from their possible future divorce and future creditors, while allowing the death benefit to be used for your children’s benefit as needed. You can create these benefits through trust-based planning. And even if a trust is not feasible, often you can create some of these benefits through good Will-based planning.