In my practice, I meet with many young parents to complete their estate planning. In most circumstances, the parents are already well along in protecting their family and have obtained life insurance on each of their lives to provide for their children in the event they both die. One of the common errors we fix during the process, however, relates to the beneficiaries named on those life insurance policies.
In the course of our financial review, we touch on life insurance policies. When I ask who the contingent beneficiaries are (after each spouse), the usual response is something like, “The kids, of course. That’s who it’s for.” That answer is understandable, but the designation can undo the plan they just built.
One of the most common techniques we use is to set up trusts for children in the event both parents are deceased. Those trusts typically provide detailed instructions about what the money can be used for and at what age it is distributed directly to the children to use as they see fit. Most parents choose to delay distribution until their children have reached an age somewhere between 25 and 40. The key is making sure the right assets actually end up in the trust, and this is where beneficiary designations often lead things astray.
Take a couple I’ll call Mike and Sarah. They have two children, ages 6 and 9. Mike and Sarah each have a life insurance policy that names the other spouse as primary beneficiary and the two children as contingent beneficiaries. If Mike and Sarah die together, the insurance company owes the money to a six-year-old and a nine-year-old, but it cannot legally pay them because Connecticut law states that a minor cannot legally receive or manage that kind of money.
Instead, the Probate Court appoints a guardian of the estate for each child to oversee the funds until age 18. That guardian may need to post a bond, file an inventory, and account to the court regularly. Significant uses of the funds can require court approval. The children’s legal guardian—the person taking care of the children, which is a different role from the guardian of the estate—must work with the guardian of the estate, and each party may spend years reporting to a judge about money meant to make life easier for the kids.
The most alarming part is what happens when the child turns 18. At that point, the court’s supervision ends and all of the money is paid directly to the child, regardless of what the trust in the will says. None of the thought and planning behind the trust applies because the insurance proceeds never reached the trust.
The fix is simple and costs nothing. The contingent beneficiaries on each policy need to be revised using the proper language to ensure the money ends up in the trust for the kids. With the proper designations, when both Sarah and Mike are gone, the proceeds will flow into the trusts we create for the children. Once funded, the chosen trustee manages the money under the terms they wrote, with limited court involvement and no automatic payout at age 18. The exact wording is something we discuss in our meeting and depends on the details of the plan.
Life insurance is often the largest asset a young family’s children will ever inherit, and it is often the only income tax-free asset. The form that controls it is one page, and it deserves the same care as the will.
The Bayer Bottom Line
- Naming minor children directly on a life insurance policy generally means a court-supervised guardianship, followed by a lump-sum payout at age 18.
- Revise beneficiary designations to ensure the insurance money follows the plan the parents created.
- Review each policy’s beneficiary form whenever the will changes.
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This post is for informational purposes only and does not constitute legal advice. Laws vary and individual circumstances differ. Consult a licensed Connecticut attorney for guidance specific to your situation.
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