Life Insurance / Retirement Account Designations and Minor Children
The Background: Naming a Minor Child as a Beneficiary
Anyone with a life insurance policy, a 401K or IRA has (or, at least, should have) designated one or more beneficiaries for that account or asset. When deciding who to list as beneficiary, it’s not uncommon to think of our children. This does, after all, make a certain amount sense: we’re looking to provide for our children, and the proceeds from a well-funded retirement account or life insurance policy could do just that. But is doing so that right fit for you, your family and your estate plan?
The Issue: Legal Challenges Facing Distribution to Minors
Listing minor children as beneficiaries on these policies and accounts, however, is problematic, because a minor child will not be able to take the payout in full until he or she reaches the age of majority. Insurance companies and retirement accounts won’t payout to minor children because of the legal inability of the child to manage payments. What essentially has to happen in that situation is that a guardian must be appointed by a court to take and manage those assets. But this can be a time consuming and expensive process, and the guardian’s management of the assets must be overseen by the courts, making court filings and accountings along the way showing how the money was invested and distributed and potentially being required to invest the money in a certain manner as required by the court or applicable law.
For this reason, owners of assets with beneficiary designations may want to consider refraining from naming minor children as the beneficiaries, particularly the primary beneficiary. While naming a child as a contingent beneficiary rather than primary makes it less likely that the child would be the payee at the time of disbursement, there is still that chance. Life is full of surprises, often unpleasant ones. Even if the child is not far from the age of majority, there again is that chance that he or should would find him or herself in the position of being a disbursement payee. In order to avoid the court-appointed guardianship requirement, therefore, minor children should not be named as the beneficiaries. This begs the question: if I want these assets to go to my kids, how do I make that happen?
Option One: UTMA/UGMA Planning
One option is to expressly gift assets to a child under the Uniform Transfers to Minors Act or Uniform Gifts to Minors Act. This effectively serves as a statutorily created trust substitute. Under this approach, assets are gifted to a minor and managed by a custodian, who has the right to collect, hold, manage and invest those assets, using them for the minor’s benefit. There are both pros and cons to this approach, however, which should be discussed with your attorney when considering how to title or give assets to children.
Option Two: Trust Planning
A second, and perhaps a more efficient and customizable option, is to utilize a trust when considering beneficiary designations. If you would like your life insurance, retirement account or other beneficiary-designated assets to go to your children at the appropriate time, you can name a revocable (i.e. living) or irrevocable trust instead of the child. This approach has many benefits, including avoiding the costs and red tape associated with the guardianship or UTMA/UGMA approach, while also retaining some control over the assets even after your passing. For instance, with a trust, you can include instructions and terms regarding how the money will be used or handled by the trustee, incremental and purpose-driven payments to the beneficiary (e.g., your child), and a predetermined age of disbursement for the child.
This last item is particularly useful. With custodial property, the age for disbursement is required by law, but under a trust a later age may be adopted for disbursement. Consider that our decision-making process at age 18 or 21 may not be as good as it is when we reach 25, 30 or 35. Think about it for a moment. That is a pretty good reason to avoid handing our 18- or 21-year-old kids a financial windfall.
Know Your Options: Consult Your Attorney and Determine the Right Fit for Your Family
For these and other reasons, it may be a good idea to incorporate a living or irrevocable trust into your estate plan. You will have the ability to fund the trust at your convenience and preference, including naming the trust as beneficiary of the retirement account or life insurance policy, as well as whatever accounts and assets you deem appropriate. This would mean an added up front cost to set up the trust. But there is a good chance that the cost would be outweighed by the benefits. Not every situation requires a trust. And some parents may feel comfortable with minor children as beneficiaries (particularly older children as contingent beneficiaries). But, at the very least, it’s worth speaking to an estate planning attorney and discussing your options regarding whether utilizing a trust or a gift to a minor under the UTMA/UGMA is right for your family.
The information herein is not legal advice and does not create an attorney/client relationship. The information is in the form of legal education and is intended to provide general information about the matter. The above is not, nor is it intended to be, legal advice. Consult your attorney with questions.