Life insurance can be one of the most important components of an estate plan. How you name your beneficiaries can have significant tax implications and can provide protection against creditors. Most people name either their spouse and/or children and don’t give it much thought. This blog outlines some things to consider as you develop your estate plan.
Designating a trust as the direct beneficiary of your life insurance policy can also protect its cash value and death benefit from creditors’ claims.
Name Someone:
All 50 states have statutes that protect the death benefit and/or the cash value of life insurance from creditor claims against your estate. Under California Civil Code § 704.100 (c), when your spouse or children are named as beneficiaries, their creditor cannot attach the insurance benefits “to the extent necessary” to provide for their your spouse or children’s support. Under Hawaii Revised Statute § 431.10-232, the entire death benefit is exempt. If you leave the beneficiary designation blank, the proceeds of the life insurance policy may be payable to your estate by default. Because your estate is responsible for paying off your debts before distributing your estate to your beneficiaries, the life insurance proceeds may be diminished or exhausted by the time they pass to your beneficiaries.
Naming Your Spouse:
If you’re married and you don’t have an estate plan that includes a Trust, then you should consider naming your spouse as the primary beneficiary. After your passing, this provides your spouse easy access to cash that may be used to immediately pay bills. If the remainder of your estate is tied up in Probate Court, these funds may be very much needed.
Minor children:
Children under the age of 18 cannot directly receive life insurance benefits. If you name a minor child as a beneficiary, an appointed guardian will likely be put in charge of managing the payout of the insurance proceeds for your child’s benefit. When they reach the age of 18, any remaining proceeds will be paid to them. This strategy raises several complications. First, it may require the additional cost of a court-appointed guardian before the proceeds can be received and used. Second, that guardian may not have much guidance on how to spend the proceeds. And third, when the remaining proceeds are eventually passed to your child(ren) they may not have the financial maturity to handle the money.
To resolve these issues, some people designate the child’s caretaker as the primary beneficiary to avoid the appointment of a guardian. This, however, does not guarantee that the funds will actually be used for the child’s benefit. Nor does it provide for any control over how those funds are spent.
A popular option to resolve these issues is to create a Trust and name the Trust as beneficiary. This allows the Trustee to take control of the funds, and gives you some control in the drafting of the Trust terms regarding how the funds will be used and at what age any remaining amounts will be passed to the children. This option is even more attractive if your children have special needs and can benefit from government assistance. Regardless of age, if one or more of your children is receiving government benefits, naming them as the beneficiary of a large sum of money may cause them to lose their eligibility for those benefits. Instead, a special needs trust can be created and named as the beneficiary of all or some of your life insurance benefits. This way, the insurance proceeds will be managed and distributed in a manner that will supplement, and not compromise the government benefits.
Naming Multiple Beneficiaries:
If you choose to name more than one beneficiary, pay attention to how you designate the death proceeds to be distributed. The designation should be clear as to how the benefits will be paid if one of the primary beneficiaries is not living at the time you pass. Note that if all your primary beneficiaries pass before you, your estate is automatically the contingent beneficiary. Your designation should also be clear on what percentage each beneficiary should receive, if you intend unequal splits.
Single Parents:
Because of the complications noted above, if you are a single parent, you should consider having a revocable living Trust as part of your estate plan, and naming the Trust as the primary beneficiary of your policies.
Naming your Revocable Living Trust:
Consider naming your Revocable Living Trust as the primary beneficiary of your life insurance policies. If you are married, the Trust can be structured so that the proceeds will pass into the “B Trust” (or Bypass Trust), created for the benefit of your surviving spouse so that the proceeds will be protected from creditors, lawsuits, and a new spouse. This also allows your spouse to use your exemption from estate taxes. If you are single, particularly with minor children, a Trust alleviates many of the issues described above.
Trusts can also provide better control for children who have a history of financial problems. Spendthrift Trusts, or spendthrift provisions in Trusts, can establish specific conditions for distributions. These provisions can be broad enough to adequately provide for their health, support, and/or education, without putting them at risk to squander funds that may need to last them many years.
Naming an Irrevocable Life Insurance Trust:
Regardless of whether you’re married or single, if you anticipate your estate will be large enough to be subject to estate taxes, you should consider establishing an irrevocable life insurance trust (ILIT). An ILIT is established by paying sufficient funds into the Trust to cover the premiums, and then naming the Trust as the primary beneficiary. This removes the value of the insurance proceeds from your estate, and therefore can eliminate the estate tax that may ordinarily be owed if it was included.
Takeaway
The use of life insurance in your estate plan offers many advantages. Consider carefully how it is to be spent, so that it achieves the goals you intended when you purchased it. With these goals, you should discuss with your financial advisor, insurance agent, and estate planning attorney your current income, other insurance policies, savings and investments, possible college and other future expenses, total debt, etc., to make sure you have the best plan to fit your needs. Contact CASHMAN LAW today for a free consultation to see how we might help you get the most out of your estate plan.
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