Families, Life Insurance and Trusts
As a parent, you understand the importance of life insurance. You’ve figured out how much life insurance you need and determined the kind of policy that fits your budget.
However, you still have some important decisions to make including who should be the owner of the policy and who should be the beneficiary.
For a married couple with children, a life insurance policy is owned by the person whose life it insures and his/her spouse is typically named as the primary beneficiary. In the event of death, insurance proceeds are paid directly to the spouse, which avoids the costs and delays of probate and potential exposure to estate taxes.
Simple, right? But what if the insured person is a single parent – or both parents pass away at the same time?
According to Gary Lardy, CEO of IntelliQuote (http://www.intelliquote.com), an online life insurance agency, families should be prepared for a variety of possible financial scenarios and options in the event of a parent’s death. “Most people don’t spend much time thinking about these scenarios,” says Lardy. “But parents should consider what might happen and plan for their children’s needs.”
There are several considerations when planning to provide financial stability in the event of your passing:
- Often minor children are named ‘contingent beneficiaries’ of a life insurance policy. Generally, insurance companies cannot pay proceeds to minor children, so courts step in and appoint a guardian. This can result in a laborious and costly system of approvals of the guardian’s actions until the child reaches the age of majority – between 18 and 21 depending upon the state – at which time he/she will inherit the balance of funds.
- Other times, close relatives are appointed contingent beneficiaries with the understanding that they will judiciously use the money to raise the children. This shelters proceeds from probate but not estate taxes. Such funds become part of the relative’s personal assets and therefore subject to their general creditors.
And, while a relative may be a good and loving person, does he/she, objectively, possess the investment knowledge necessary to manage relatively large sums of money over long periods of time, the success upon which your children’s futures depend?
- In a third scenario, the ‘estate’ is designated the contingent beneficiary of life insurance policies. Insurance proceeds paid to the estate become subject to probate, the estate’s general creditors and, potentially, estate taxes.
There is an additional option to help preserve your wishes and protect your beneficiaries and life insurance proceeds from probate and estate claims or taxes:
establishing a trust.
TRUSTS: Trusts fall into two categories: Testamentary Trusts (those established by a Will at death) and Inter Vivos Trusts (those established during life):
- Testamentary Trusts. A provision is added to your Will that provides for the establishment of a trust for the purpose of distributing funds to raise and educate minor children following your death. Once the children have become self-sufficient, the Will can be modified during your lifetime, removing the testamentary trust provision.
- Inter Vivos Trusts. These trusts, established during life, may be either revocable or irrevocable:
- Revocable. Ownership of an asset, in this case a life insurance policy, is transferred to a trust. Control of the policy is retained and the trust may be changed or revoked at any time. At death, insurance proceeds bypass probate and are distributed per the terms of the trust. As the need for insurance coverage changes over time, this flexibility can be quite valuable. The drawback of a revocable inter vivos trust is that the insurance proceeds will be subject to estate taxes.
- Irrevocable:Most commonly referred to as anIrrevocable Life Insurance Trust (ILIT),ownership of an asset, in this case a life insurance policy, is transferred, irrevocably, to a trust. Ideally, the insurance policy is purchased after the trust is established, as transferring an existing policy to an ILIT results in a 3-year look-back period – meaning if death occurs within that period, insurance proceeds become part of the estate.
- With an ILIT, a third-party trustee is designated and the trust becomes both the owner and beneficiary of the insurance policy. Premiums are ‘gifted’ by the insured person and the trustee uses such gifts to pay premiums. Beneficiaries of the trust, usually the insured’s spouse and/or children, receive the insurance proceeds, avoiding probate, general creditors of the estate and estate taxes.
As parents and family members, we know we should prepare for the future financial security of our loved ones in the event of an untimely death. Lardy suggests taking the first step by discussing your situation with a licensed life insurance agent and an estate planning attorney to determine which of these scenarios work best for you.
PR Newswire Association LLC
EL DORADO HILLS, Calif.,Jan. 26, 2012/PRNewswire/