In Divorce: Naming Your Child as Your Life Insurance Beneficiary

What happens when you name a child as a beneficiary?

A child may be one of the first people to come to mind when naming beneficiaries. If you’re a parent, your little one is probably one of the primary reasons you are buying a policy. You want to leave them a financial legacy to make their lives easier.

However, if your children are still minors, you need to take additional steps if you choose to name them. A life insurance company will not release a policy payout to a child who has not reached the “age of majority,” which is typically 18 or 21 depending upon the state.

If a minor becomes the beneficiary of a life insurance payout, then the decision regarding what to do with the proceeds is in the hands of the probate court. There, they will name a guardian for the minor’s estate, and the guardian retains oversight over the estate and its money until the child reaches the age of majority. It’s not an ideal scenario because there are fees associated with the court overseeing the distribution of assets. The process and its associated costs could prevent the money from being utilized the ways you envisioned.

So, how can you overcome this obstacle to ensure that your minor children receive the payout?

List a custodian

You must assign a custodian for the kids.

A custodian serves as the property guardian of the money and assets intended for the minor child, making way for valid transfers under the Uniform Transfers to Minors Act (UTMA). A properly designated custodian may make decisions concerning those assets so long as the choices are in the best interests of the minor child. Once the child becomes of age, the assets are turned over to him or her, and the custodian no longer has a role to play.

As an example of how this might work is, say you are a single parent and decide to name your child as the primary beneficiary on a life insurance policy. When asked to name a custodian, you list your older sister because she would be your child’s “property” guardian if anything happened to you. Your sister would then be in charge of financially managing the life insurance proceeds until your child reached the age of majority. Your sister could protect these funds by depositing them into an UTMA account for the child. She would become the custodian of the UTMA and the child would become the irrevocable (non-changeable) beneficiary until the child reaches the age of majority.

Name a living trust as beneficiary

Another way to avoid the potential challenges of naming a child as a beneficiary is to name a trust instead. When applying for a life insurance policy, you can list your trust directly as a primary beneficiary.

A revocable trust, also known as a living trust, is a popular estate planning tool that you can use to indicate who will receive your assets when you die. Assets held within a trust are commonly things like money, a house, life insurance, retirement plans and more. A trustee manages the trust and ensures the correct individuals receive their benefits in the event of your death. The “living” and “revocable” in this trust’s name refer to the fact that you can adjust which assets are in the trust and who the beneficiary is as your circumstances or wishes change. Knowing that you can work with a trustee to add or remove assets or make a change to beneficiary designations over time can give you peace of mind.

You can also create an irrevocable life insurance trust (ILIT) if you’d like to reduce estate taxes and leave a larger inheritance for your loved ones. Unlike revocable living trusts, an irrevocable trust cannot be adjusted after it is created, so think carefully before you decide how your money and assets will be distributed. Talk to a financial advisor to learn which type of trust might be best for you, and how to identify a trustee to help you complete the process.