Informal Estate Planning
With few exceptions, almost everyone we meet with to discuss estate planning has one overriding goal if they should pass away unexpectedly – to make sure their children will be cared for. Oftentimes, we hear how people have taken their own “informal” measures to accomplish this goal. Unfortunately, such informal” measures can have unwanted and unexpected consequences.
One example is when a parent with young children names a sibling or other relative as the beneficiary of a life insurance policy, with the expectation that he or she will use the money to take care of the children. The reason for doing this is valid – children are not able to manage their own finances, particularly the large sums of money that are usually paid out under life insurance policies. However, although the intent is good, there are all kinds of reasons not to do this type of planning. Here are just a few examples:
1. There is no assurance that the life insurance beneficiary (the relative) will use the money for the child’s benefit in the manner that the parents envisioned. In fact, there is nothing to prevent the sibling from keeping the money all for himself or herself – he or she has no legal obligation to spend it on the child. If the relative wants to go blow it all at the gambling boat, there’s nothing to stop him.
2. The funds are subject to the debts and liabilities of the relative. If he or she has significant debts or gets sued for some reason, then the life insurance money could all be lost.
3. Since the funds are legally the property of the relative, the income that is generated from the funds (assuming they are invested) is taxable income to the relative, and could potentially push the relative into a higher tax bracket.
4. Even if the relative fully intends to spend the money on the children, he/she would have complete discretion as to how and when the money is spent, and this may not be what the parents would want. What’s to prevent the relative from buying the child a Ferrari when he turns 16, rather than spending it on college?
5. What if the relative has his own children? He may think it unfair that he be expected to spend the money on your children, but not his children. And of course, there’s nothing to stop him from spending it on his own family.
6. What if the relative gets a divorce? The insurance funds might be deemed marital property and end up in the hands of the ex-husband or ex-wife.
What’s A Better Solution?
As you can see, this kind of “informal” planning can lead to all kinds of unintended problems. Fortunately, there is a fairly simple way to accomplish your goal of making sure that the insurance funds are held for your kids benefit without all of the problems listed above – CREATE A TRUST AND MAKE IT THE BENEFICIARY OF YOUR LIFE INSURANCE.
You can create a trust for the benefit of your kids, which contains specific instructions as to how the trust funds will be managed and spent. You have practically unlimited say in how you want the money spent. Upon your death, your life insurance proceeds will be paid to the trust, and the trustee (whomever you designate to manage the trust) will have a fiduciary duty to the beneficiaries (your children) and will be legally obligated to follow the terms of the trust. Furthermore, if properly drafted, then as long as those funds are held in the trust, they will be protected from your children’s creditors.
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Thanks for the tips.
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cb-vb 
Len from 
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It’s very important to make plans in case of your death – even if you are young. You never know what might happen so it is worth the minimal effort just in case, and make sure your children are taken care of (in every way) as best as possible.