Investing in life insurance is a foundational part of estate planning. However, these five mistakes when naming life insurance beneficiaries could lead to potentially dire consequences for the very people you’re trying to protect and support.
1. Failing to name a beneficiary
Far too many people fail to name any beneficiary at all. Others make the mistake of naming “my estate” as the beneficiary, rather than listing a specific person. Both of these errors will mean your insurance proceeds will have to go through the court process known as probate.
Probate can tie up the benefits for months or even years and opens up the proceeds to your estate creditors, which could totally wipe out the life insurance proceeds. Your policy should have at least one primary beneficiary and at least one contingent (alternate) beneficiary.
2. Failing to keep beneficiaries updated
Sometimes, not keeping your beneficiary designations up to date can be even worse than failing to name one! This is particularly true if your ex-spouse is named as the beneficiary. If you are remarried, your current spouse would likely receive none of the policy benefits when you die. He or she would be really mad at you, to boot!
You should review your beneficiary designations annually as part of an overall review of your estate plan. Additionally, you should update your beneficiaries upon events like divorce, deaths, and births. When you are a client of ours, we have built-in systems to ensure your beneficiary designations (along with all other documents in your plan) are regularly reviewed and updated.
3. Naming a minor as beneficiary
Though you are technically allowed to name a minor child as beneficiary, it’s never a good idea. Minor children cannot receive insurance benefits until they reach the age of majority. If a minor is listed as the beneficiary, a court-appointed guardian will have to manage the funds for the child until they’re 18, at which time all benefits will be distributed to him/her outright.
Even if the child has a living parent, the court has to appoint a guardian. The parent would have to petition the court to be appointed guardian, and they may not be appointed if they cannot qualify or pay for a bond. In many cases, a court could deem a parent unsuitable (if they have poor credit, for example) and instead appoint a paid fiduciary to control the funds.
Rather than naming a minor as beneficiary, you should set up a trust to receive the insurance proceeds. You would then someone as the trustee to manage the funds for the minor child. By doing so, you get to choose not only who would manage your child’s money, but also how and when the funds are distributed and used.
4. Naming an individual to ‘handle the funds’ for a child
We’ve had many clients tell us they named their sister/brother/other relative or friend as the beneficiary so that person can manage the funds for the client’s child. This is a really bad idea and one of the worst and most common mistakes we see! If that relative or friend dies without properly setting up a trust fund for your child, all of your insurance proceeds would go to that person’s family rather than to your child. They could also mismanage it, use it for themselves, or lose it to a judgment creditor. In addition, they also may have to report the funds as a gift to your child and file a gift tax return.
Naming an individual with special needs as beneficiary
Although a loved one with special needs is likely one of the first people you’d think of naming as beneficiary of your life insurance policy, doing so can have tragic consequences. If you leave the money directly to someone with special needs, it could disqualify that individual from receiving much-needed government benefits.
Rather than naming someone with special needs as beneficiary, you should create a “special needs trust” to receive the insurance proceeds. This way, the money won’t go directly to the beneficiary upon your death, but it would be managed by the trustee you name and dispersed according to the trust’s terms, without affecting benefit eligibility.
Don’t create problems
While naming life insurance beneficiaries might seem like a simple task, if you’re not careful, you can create major problems for the people you most want to protect. Meet with us today to be certain you’ve done everything properly and have the right estate planning in place.
