A common mistake, particularly with young parents who come into my office, is the naming of minor children as beneficiaries to financial assets such as life insurance, retirement accounts, or beneficiary designations on brokerage accounts. I can best illustrate this by example:
Assume that Joe and Sally Youngparent have two children, Bobby (age 12) and Brenda (age 8). Joe owns a $500,000 life insurance policy on his life, and he has named his wife Sally as the primary beneficiary. He then names Bobby and Brenda as equal contingent beneficiaries. If Joe and Sally were to die together in some sort of an accident, the idea is to provide funds to raise both Bobby and Sally.
Here’s the problem: the life insurance company won’t pay directly to Bobby and Brenda, because they are minors. Until Bobby and Brenda are at least 18 years of age, the life insurance company will insist that a guardianship be established through the court system before paying the death benefits. Then the court appointed guardian would have to manage the funds and provide accountings annually to the court. As you might imagine, this is an expensive process.
Why won’t the life insurance company pay to the guardian established in the estate? This is due to a number of different laws, but the bottom line is that the life insurance company doesn’t want to get sued when the children become adults if the funds weren’t handled properly. The life insurance company therefore uses the legal process to protect itself.
And it isn’t just life insurance companies that have to worry. Retirement account custodians, brokerage and mutual fund companies, banks and other financial institutions all have to do the same thing if a minor is named as a direct beneficiary to an account.
On top of all that, even with the court appointed guardian, in the scenarios I describe the children will have access to their funds upon turning 18 years of age. Would you expect an 18 year old to make wise decisions with a lump sum of cash when their parents weren’t around to guide them?
So how does one avoid this mess? Easy. Establish a Revocable Living Trust. In the trust name a trustee and designate how the children’s funds are to be used for their benefit. Then instead of naming the children directly as beneficiaries, name the trust as the contingent beneficiary. Problems solved.
Of course, consult with your own counsel when establishing any such trust and designating the trust as a beneficiary to any account. There are a variety of legal and tax consequences that should always be addressed in these types of circumstances.