How Your Life Insurance Policy Can Ruin Your Child's Life (Or At Least His Marriage)

I cannot overemphasize how important having the right insurance coverage is.  If you have a minor child, it is especially critical that you work with a good life-insurance advisor.  It's how you can ensure that your child's legal guardian will have the resources to adequately care for your child if the unthinkable happens to you.   

Of course, as a thoughtful parent, you'll want to do more than just invest in a good life insurance policy.  You'll also want to make the right decisions about how the proceeds of that policy pass to your child.  In part, that means avoiding three very big planning mistakes. 

Mistake One:  Making Your Child's Legal Guardian Your LIfe Insurance Beneficiary.  You should avoid making the benefits of your life policy payable outright to your child's guardian if something happens to you.  Once that money is distributed to the guardian, it's the guardian's money (i.e., not your child's money) in every legal sense. 

Why is that a problem?  Well, what would stop the guardian from betting it all at the local race track in a moment of weakness?  Similarly, who would prevent the guardian from spending it all on himself or giving it all away to her favorite causes?

Even if your child's guardian is the most reliable and trustworthy person on Earth, having him or her be the beneficiary of your life insurance policy is not a good idea.  The guardian could still lose the insurance money in a lawsuit, even one that has nothing to do with your child.  Plus, if the guardian goes through a divorce, half of the insurance proceeds would probably leave with the ex-spouse.  Finally, any money that's left over if the guardian passes away would be includable in his or her estate for tax purposes, meaning a good chunk of it could go to the government instead of your child (assuming the guardian chooses to leave it to your child).    

Mistake Two:  Making Your Minor Child Your LIfe Insurance Beneficiary.  If you pass away and your child is the beneficiary of your life policy, the proceeds must go into a guardianship estate supervised by the probate court.  Your child’s legal guardian will then have to wait six months or more every time they need to be reimbursed for an expense. That can cause real hardship for your child and their caregiver. Plus, there will be accounting fees and other costs associated with maintaining the guardianship estate.

That’s very bad, but it’s not the worst consequence of designating a minor child as your life insurance beneficiary.  No, the worst consequence is that your child will get whatever insurance money is left over when he or she turns 18 –- no strings attached!

A quick story illustrates just how destructive that kind of inheritance (i.e., an "outright" inheritance) can be. When he was 18, my friend's ex-husband inherited $150,000. His life was so easy at that point that he never learned to budget or manage money.  Instead, he got married (too young) to my friend, blew his inheritance, and fought with his wife quite excessively about their finances.  Years later, my friend is convinced that a major factor in the demise of her marriage was that outright inheritance at the wrong time.

And that is how your life insurance policy can ruin your child's life (or at least his marriage).

Mistake Three:  Not Planning So Your Life Insurance Proceeds Go Tax-Free To Your Child.  Many people believe that life insurance is entirely tax free to the owner.  It isn't.  Unless you do the right kind of estate planning, up to 45% of the proceeds could be lost to the government in the form of estate taxes.  You aren't paying those premiums simply to increase the public coffers, right? 

Fortunately, there is no reason why you need to make any of the mistakes identified above.  Your minor child should and can benefit from every penny of life insurance you buy.  If you want absolute peace of mind when it comes to protecting your child fully, please contact us. Together we can ensure that your child's guardian has the legal responsibility to use your life insurance to care appropriately for your child.  We can also make sure that whatever money is left when your child grows up goes to him or her in exactly the right way.  In fact, we can even protect that money from lawsuits, divorce and estate taxes.  We can do all of this through the right combination of one or more carefully drafted trusts and your policy's beneficiary designation form. 

But the time to plan is now.  Life insurance only gets more expensive as time passes.