Hunt & Associates P.C.

Life Insurance and Estate Planning Considerations for Individuals with Minor Children

The use of life insurance is an important tool in the estate planning process.  Married couples with children will obtain life insurance to make sure that that the surviving husband or wife and children are taken care of in the event of a spouse’s untimely death.  Divorced individuals may also have life insurance policies to ensure their children receive appropriate support following their death.

For either the divorced or married policy holder, having life insurance is not enough, the policy holder needs to make sure that the proper beneficiaries are designated in the life insurance policy so that the proceeds will go to those that you intend on benefiting.   The policy holder also needs to ensure that they have a testamentary trust (to be explained further in this article) that can hold the proceeds and any other property that the couple intend on leaving their children.

Married individuals generally want their spouse to receive the insurance proceeds and then their children.  Many policies name the insured’s spouse as a primary beneficiary and the insured’s children as contingent beneficiaries.  Some policies do not designate a contingent beneficiary.  Some policies are set up to leave the proceeds to a sibling or family friend; the couple relying on blind faith that the person they leave the funds to will use it for their children’s benefit. These designations are problematic.

By leaving the insurance proceeds to the children or by not designating a contingent beneficiary, if the children are under the age of 18 then the money will need to be placed in a conservatorship.  This process requires conservatorship proceedings in which a court will appoint a conservator to manage the life insurance funds and other property left to the children, which is the common result where a couple do not have wills or the wills they have do not contain a testamentary trust.

The conservator may be a family member, family friend, or a professional conservator. The court ultimately decides who will serve as conservator.  Generally, the conservator’s ability to access the funds is restricted unless the conservator posts a bond, except in the case of a professional conservator.   When the children turn 18, the conservatorship is terminated and the funds are given to the children.  In practical terms, your children could receive $100,000, $500,000 or $1.0 million in cash when they turn 18.  In Oregon, a conservatorship may be extended until a child reaches 21 under limited circumstances.  However, a court must approve such an extension and most courts are leery to extend the conservatorship beyond the age of 18.

Some problems with a conservatorship are: (1) the children get all of the funds and other assets when they turn 18; (2) the process can be expensive; (3) the conservator’s ability to use the funds for the benefit of the children may be greatly restricted; and (4) the court may appoint somebody as conservator that the parents did not want to handle money on behalf of their children.  Of course, some people like conservatorships in that the court supervises the process and ensures that the funds are being used properly.

Divorced individuals also need to be concerned that their ex-spouse would have control over the life insurance proceeds.  Many people would like to avoid this result entirely.  Of course, if a court orders the individual to maintain life insurance on his life while that individual is paying his ex-spouse child support, then the ex-spouse must be the designated beneficiary.

Individuals with minor children should have at the very least a will or revocable living trust that contains a trust for minor children.  This type of a trust is called a testamentary trust since it does not exist until after the individual dies.  Any property placed in this trust will be managed by the trustee designated in the will or revocable living trust and used for the purposes designated in the trust – such as to assist children with their educational expenses and health.  The trust can also contain provisions that allow the trustee to make distributions to the children upon reaching a certain age or an achievement, such as graduating from college.

Additionally, if you have debt (student loans, home loans, and credit card bills) your creditors will not be able to go after the property placed in the testamentary trust, since your trustee and not your estate is the actual owner of the property placed in the trust.  If you made the mistake of designating your estate as the contingent beneficiary or not designating a contingent beneficiary, then your creditors would be able to receive payment on their claim from the life insurance proceeds.  Since most people have some form of debt, making the correct designation is extremely important to ensure that the life insurance proceeds are available for your children’s future and not to pay for your past debts.

Once established and funded the testamentary trust is not subject to court supervision and the costs of managing the trust property are relatively low.  However, since there is no court supervision the risk of theft or fraud by the trustee is higher.  Consequently, it is important that the trustee you designate is trustworthy and able to manage large sums of money.  You may want to consider designating a professional trustee (such as a bank or financial institution’s trust department) as the trustee.

To ensure that life insurance proceeds are distributed to the testamentary trust, the life insurance policy should designate the contingent beneficiary (if the insured is married) or primary beneficiary (if the insured is divorced or unmarried) as the trustee of the testamentary trust created in the will or revocable living trust.  For example the designated contingent beneficiary may be “the Trustee of the John A. Doe Testamentary Trust”.   Life insurance companies may prefer different designations, so it’s important to consult with your financial advisor in making this designation.

By having a testamentary trust for the benefit of a minor child, the policy holder can ensure that insurance proceeds are used for the benefit of the policy holder’s child and eventually distributed to the child in an amount and at a time that the policy holder determines.  Of course, a testamentary trust is only one estate planning tool and you need to consult with an estate planning attorney to determine whether the use of a testamentary trust is appropriate or whether another estate planning tool would better fit your needs.

©11/22/2010 Kevin J. Tillson of Hunt & Associates, PC

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