Jay Scheiner, Executive VP
You are an insurance advisor meeting for the first time with your new clients, Jim and Deb. You asked them to bring, among other documents, their current insurance policies and their Wills to the meeting. This married couple, around 40 years old, have twin daughters, Dana and Donna, age 10. While reviewing their current life insurance policies, you notice that their beneficiary designations are not what they should be.
Jim’s Policy Primary Beneficiary: Deb, spouse of the insured. Contingent Beneficiaries: Dana and Donna, children of the insured.
Your clients should not name their minor children as direct or contingent beneficiaries, since a life insurance company can’t pay out proceeds directly to children until the children reach the age of majority, typically 18 or 21 depending on state law.
In most jurisdictions, to protect the interests of a minor, state law requires appointment of a guardian or trustee to administer proceeds payable to the child. Appointment proceedings will delay access to the death proceeds and generate unnecessary legal and administrative expenses. As important, the fiduciary named by the court may not be the one the insured would have chosen if they had made this decision during their lifetime.
Deb’s Policy Primary Beneficiary: Jim, spouse of the insured. Contingent Beneficiaries: (none indicated).
Your clients should designate a contingent beneficiary in all of their life insurance policies, and the beneficiary designation should be worded in a way that will best benefit their children.
Having no named contingent beneficiary is the same as naming the insured’s estate as the beneficiary. Is this a bad thing? It can be; in the absence of a Will designat- ing a guardian or trustee the courts will intervene, which may cause long, frustrat- ing delays. The courts could also impose restrictions on how the proceeds will be spent or distributed, which may be contrary to what the insured would have wanted for their children.
While Jim and Deb will go to great lengths to protect their children (that’s a major reason they purchased the life insurance), they need you, the insurance advisor, to help them find appropriate solutions. It is therefore important that the beneficiary designations allow for the distribution of the life insurance proceeds in the most disciplined manner possible to provide maximum benefit to their children when the parents are gone.
Okay—here are some practical ways to ensure that minors, through the people entrusted with their care, have access to the life insurance proceeds intended for them:
• Make the contingent beneficiary of the insured’s life insurance policy a Testamentary Trust in the insured’s Will. The terms of your client’s Will can contain this trust, which does not spring to life until the death of the insured. Referencing the trust in the Will is a precise way to ensure that the parent’s exact wishes for their children are followed. The trust, which is a legal document, names the person the insured chooses as the Trustee, and describes how the parent would like to have the money managed and spent and for how long. An 18-year-old may be an adult under the laws of many states, but the client’s testamentary trust could be written to keep the newly-minted adult from frittering the money away before he or she is 25 or 30.
In our example, the contingen beneficiary section of the life insurance application would state: (Trustee’s Name) as Trustee under (Article X) of (Jim or Deb’s) Last Will and Testament dated (January 1, 20XX).
• Taking advantage of the Uniform Transfers to Minors Act (UTMA) is an excellent way to ensure that children receive proceeds from a life insurance policy, especially if the parents have not yet executed their Wills. Under the UTMA, the parents would name an adult custodian who is given the discretion to make distributions for the minor’s welfare. The UTMA account (which is essentially a statutory trust) allows parents to choose a custodian— a person they trust—who would man- age the life insurance death proceeds, and other assets they might have in the account, as they see fit prior to the children reaching majority.
Some insurers have a specific form to assist in making a beneficiary designation with UTMA custodian the beneficiary or contingent beneficiary of a life insurance policy.
If no special form is available, the following wording would generally be accepted: (Custodian’s Name) as custodian for (child’s name) under the (State) Uniform Transfers to Minors Act. However, you should confirm with the insurance company the specific wording they would accept.
• Designate a Living Trust as beneficiary or contingent beneficiary in place of the child directly. This is similar to the testamentary trust referenced above, except that a living trust exists at the moment it is executed, whereas the trust in the client’s Will (testamentary trust) begins its life only at the insured’s death. Like the trust in a Will, a living trust allows the insured to detail the terms and conditions of gifts and plan for every contingency. The downside of this type of trust is that it will require some level of administration from the outset. If your client has a child with special needs, your client should have a living trust. If their net worth is in the tens of millions, it’s a no-brainer, and in that case the trust should be irrevocable.
Conclusion: Your clients rely on you to help them make good decisions with respect to their life insurance. These skills can separate you from those less knowledgeable. Your ability to immediately spot planning flaws (minor children as direct beneficiaries or silence as to contingent beneficiaries) may get your client to open up to you and begin talking about what is important to them. Your understanding of, and the ability to explain, the various beneficiary options is just one of many skill sets you should pos- sess. While it may seem like a big job to get this step right, keep in mind that not doing so could have repercussions for your clients’ heirs for many years to come.