When you bought life insurance, you probably were not thinking about beneficiary designations as an estate planning issue. You were thinking about protecting your family.
Maybe you bought the policy when your first child was born. You chose a death benefit that seemed substantial, named your spouse as beneficiary, set up automatic payments, and felt better knowing there would be money available if something happened to you.
That was a good decision. But life insurance is not something you should set up once and then forget about for the next 10 or 20 years.
Families change. Income changes. Mortgages get larger. Children are born. Marriages begin and end. Businesses are started. Parents begin depending on adult children for help. Estate plans are created or updated. Meanwhile, the life insurance policy may still contain beneficiary designations made years earlier.
September is Life Insurance Awareness Month, which makes it a good time to pull out your policies and look at them again. The question is not simply whether you have life insurance. You also want to know whether the coverage and beneficiary designations still accomplish what you intended.
Has Your Life Insurance Kept Up With Your Life?
The amount of insurance that made sense when you purchased the policy may not make sense anymore.
Consider a family with a $500,000 policy. If the insured spouse earns $100,000 a year and the family would need five years of income replacement, the entire death benefit could be consumed by that need alone. Add a mortgage payment of $2,400 a month, childcare for two children, college savings, final expenses, and an emergency reserve, and $500,000 may not provide nearly as much protection as it once appeared to.
That does not mean there is one formula for determining how much life insurance every family needs. There is not. It means the amount should be evaluated against the responsibilities the policy is intended to cover today.
During a life insurance beneficiary review, I also want to know what has changed since the policy was issued. Have you married or divorced? Had another child? Started a business? Taken on substantially more debt? Become financially responsible for a parent? Created a revocable living trust? Does someone in the family now have special needs?
Those changes matter because life insurance is supposed to solve a real financial problem for the people who survive you. If the problem has changed, the policy may need to change with it.
Be Careful About Naming Minor Children Directly
Parents sometimes name their children as life insurance beneficiaries because the entire purpose of the policy is to provide for those children.
The intention makes perfect sense. The beneficiary designation may not.
A minor child cannot simply take control of a substantial life insurance payment. If a minor is named directly and there is no appropriate planning structure already in place, court involvement or some form of custodial arrangement may be necessary to manage the money, depending on the circumstances.
More importantly, the result may give you far less control over how the proceeds are managed than you expected.
Imagine leaving several hundred thousand dollars for a child who loses a parent while still young. Your concern is probably not simply getting the money into that child’s name. You care about who will manage it, whether that person will exercise good judgment, what the money can be used for, and when your child will eventually be responsible for managing the remaining funds.
Those decisions belong in the estate plan.
A properly designed trust can allow the life insurance proceeds to be managed by the trustee you choose and used for things such as housing, education, health care, activities, travel, or other opportunities you want your child to have. The trust can also provide protection beyond childhood rather than requiring your child to receive everything outright at the earliest possible opportunity.
For parents of minor children, I also coordinate this with a Kids Protection Plan® so the people responsible for caring for the children and the people responsible for managing their inheritance are deliberately chosen. Those may be the same people, but they do not have to be.
The life insurance provides the financial resources. The estate plan determines how those resources will actually be used to care for your children.
Your Trust and Beneficiary Designations Have to Work Together
Creating a living trust does not automatically cause your life insurance proceeds to be paid to the trust.
Life insurance is governed by the policy and its beneficiary designation. If your spouse is named individually, the proceeds will generally be paid to your spouse. If your children are named, the insurer looks to that designation. Your will does not automatically override the beneficiary form simply because it contains different instructions.
That is why I regularly find problems when reviewing otherwise good estate plans. Someone created a trust but never changed the life insurance beneficiary. A former spouse is still listed. A child born later is not addressed. The contingent beneficiary is blank. Or the policy refers to a trust that has since been amended, restated, or replaced.
Naming a trust can be an excellent planning strategy, but it needs to be done deliberately. The beneficiary designation must properly identify the trust, and the trust itself needs provisions that make sense for the people who will ultimately benefit from the insurance.
This becomes especially important when a beneficiary has special needs and receives, or may someday receive, means-tested public benefits. Leaving life insurance directly to that beneficiary could interfere with eligibility for certain programs. Appropriate special needs planning can allow the inheritance to be managed for the beneficiary without creating the same result.
The same principle applies when you want inheritance protection because of concerns about divorce, creditors, lawsuits, addiction, financial inexperience, or simply a beneficiary who would benefit from having someone help manage substantial assets.
The word “trust” on a beneficiary form is not the planning. The policy designation, trust provisions, trustee selection, and family circumstances all have to work together.
The Owner of the Policy Matters Too
Most people focus on who the beneficiary is, but ownership can be just as important.
The owner controls the policy. Depending on the policy, that may include the ability to change beneficiaries, borrow against cash value, surrender the policy, or make other important decisions.
Ownership can also have tax consequences.
Life insurance proceeds paid because of the insured person’s death are generally not included in the beneficiary’s federal gross income. That favorable income tax treatment does not mean life insurance is outside the tax system altogether. Policy ownership and retained rights in the policy can affect whether proceeds are included in the insured person’s taxable estate for federal estate tax purposes, and transferring an existing policy can create additional tax considerations.
For many families, federal estate tax will never become an issue. For families with larger estates, however, policy ownership deserves careful attention rather than making a change to a beneficiary or owner without first considering the consequences.
This is one reason I do not recommend changing beneficiary designations in isolation. Your insurance professional should evaluate the policy itself. Your financial advisor may help determine how much coverage is appropriate. Your CPA or tax advisor may need to evaluate tax consequences. My role as your estate planning attorney is to make sure the legal structure and family plan fit with the work those professionals are doing.
What Is the Insurance Money Supposed to Make Possible?
When I review life insurance as part of an estate plan, I am interested in more than the death benefit printed on the statement.
What is that money supposed to do for your family?
Perhaps it allows your spouse to remain in the family home without immediately worrying about replacing your income. Maybe it gives a surviving parent the ability to work fewer hours while the children are young. It could pay for college, provide additional support for a child with special needs, give your family time before deciding whether to sell a business, or simply create financial breathing room during an incredibly difficult period.
Once we understand what the money is supposed to accomplish, we can evaluate whether the policy, beneficiary designation, and estate plan support that purpose.
Your family should also know enough to find the policy when it is needed. Someone should be able to identify the insurance company and know where the policy information is maintained. Your estate planning records should reflect the policies you own so that your family is not searching through years of emails and bank statements trying to figure out whether coverage exists.
Life insurance works best when it is treated as part of the estate plan rather than as a completely separate financial product.
Use Life Insurance Awareness Month to Review Your Plan
Start by obtaining a current beneficiary confirmation for every life insurance policy you own, including policies provided through an employer. Look at the policy owner, insured person, primary beneficiary, contingent beneficiary, and current death benefit.
Then compare that information with the estate plan you have today.
Do not assume that because your trust was updated, your insurance was updated with it. Do not assume the beneficiary designation you completed 12 years ago still reflects what you would choose today. And before making changes, particularly if you are considering naming a trust or changing ownership, make sure you understand how that change fits into the rest of your planning.
At Cheever Law, APC, I look at life insurance as one part of the larger Life & Legacy Plan you are creating for the people you love. During a Life & Legacy Planning® Session, we review your estate plan, assets, beneficiary designations, family circumstances, and the people you have chosen to step in when you cannot.
If you already have an estate plan, we can review what you have and identify gaps created by changes in your family, finances, assets, or the law. If you do not yet have a plan, the process will help you get financially organized, understand your options, and make informed decisions about what should happen for the people you love if you become incapacitated or when you die.
To learn more about our Life & Legacy Planning process, contact Cheever Law, APC or schedule a 15-minute introductory call.