One of the most important components of an estate plan is life insurance. People usually buy life insurance to prevent their spouse, children, or other dependents from enduring financial hardship if they pass away unexpectedly.

Many people think that all they need to do is simply write in the name of the person they want to receive the proceeds from their insurance policy on the beneficiary designation section of their paperwork and they are good to go. However, there are several important factors everyone with life insurance should consider.

Consider Naming a Trust as the Beneficiary

It is common practice for people to select the person they would like to benefit as a direct beneficiary of their life insurance policy. If you want to make funds available for your spouse?s retirement, it might make sense to name him or her as the primary beneficiary. However, depending upon your personal circumstances, financial objectives, and who you are trying to protect, it may make more sense to name a trust as the beneficiary. For some people, it will be advantageous if the life insurance proceeds are held, managed and distributed according to the terms you have established in your trust rather than having a large cash payment go directly to them.

Minor children. Life insurance companies will not pay insurance proceeds to children under the age of majority (in Utah, this the age of 18). As a result, if you list your child as a primary beneficiary, but die when he or she is still a minor, a court-appointed guardian/conservator will be appointed to manage the payout of the death benefit for your child. Keep in mind, however, that this guardian/conservator may or may not be someone you would have chosen to oversee this important role. Similarly, this individual may not manage the proceeds in the way you would have liked.  Plus, any proceeds that have not been spent (which hopefully are most of them!) will likely be distributed directly into their hands when your child reaches adulthood at 18–whether they are mature enough to be trusted with such a windfall or not. This can be avoided by simply naming the trust as the primary beneficiary of the life insurance policy.  Your child is then named as a beneficiary of the trust. Thus, the life insurance benefits will be controlled and cared for by the person you have chosen to be the trustee of your trust with the proceeds being distributed to your child according to the timeline you have established and according to your wishes and desires.

Another tactic employed by some people includes mistakenly designating the child?s caretaker as the primary beneficiary in an effort to avoid the appointment of a guardian. However, there is no guarantee that the money will actually be used for the child?s benefit, and, more importantly, the proceeds become vulnerable to claims made by the caretaker?s creditors. Again, these types of problems can be prevented by naming a trust as the primary beneficiary and then ensuring that you name someone you have faith in to serve as the trustee of that trust.

Government benefit recipients. Although you may mean well and have the best of intentions, naming someone who is receiving need-based government benefits as a primary beneficiary of your life insurance policy may have the disastrous effect of causing them to lose their eligibility for those benefits. To avoid such a disaster, you can create a special needs trust that is then named as the primary beneficiary of your life insurance policy. This type of planning serves to manage and distribute the insurance proceeds in a way that will supplement instead of compromising the government benefits.

Possible beneficiaries who may be spendthrifts. If you have concerns about a potential beneficiary of your insurance proceeds being a spendthrift (aka not being financially responsible), making them a primary beneficiary could setting them up for trouble. The insurance money could be squandered and spent on things you never intended the proceeds to be used for. Similar to dealing with minors, you can name a trust as the primary beneficiary of your insurance policy; then by naming the individual as the beneficiary of the trust, you can put measures in place that spell out specific conditions for distributing money to that person. These measures can include, for example, that the distributions be only education, maintenance or health purposes.

Think About Asset Protection

Naming a trust as the direct beneficiary of your life insurance policy can also protect its death benefit and cash value from potential creditors? claims.

Protection against creditors. Every state has laws that protect the death benefit or cash value of life insurance (and sometimes both) from creditor claims. In Utah, this protection is limited to policies that have been in existence for longer than one year. In other states, however, the exemptions are limited to a specific dollar amount or to the amount reasonably necessary to support a beneficiary. Additionally, under Utah law, the exemption is limited the debtor, the debtor?s spouse and children, or a trust set up for the benefit of these individuals. Thus, creating a special trust called an irrevocable life insurance trust (ILIT) and naming it as the primary beneficiary of your policy can be a useful strategy employed to protect proceeds that are outside the scope of the statutory exemption.

While it may seem obvious, keep in mind that it is important that you actually name beneficiaries for your life insurance policy. If you do not make these designations, by default the insurance company will pay the proceeds of policy directly to your estate. Since your estate is responsible for paying off any debts you leave behind, having the proceeds go directly to your estate may have the unintended consequence of having the insurance proceeds used to satisfy your creditors? claims. This could result in the individuals you want to benefit being left empty-handed. On the other hand, if you want the insurance proceeds to be used to pay off your outstanding debts, you may choose to do this intentionally. However, if your main goal is to ensure the needs of your family are taken care of, you will need to designate them, or a trust created for their benefit, as the beneficiary of the policy.

Protection against your loved ones? creditors. Even if your spouse, children or other loved ones do not currently have existing creditors, things can change in the future, and they may eventually face bankruptcy, divorce, or lawsuits. If they are named as primary beneficiaries of your insurance policy, the death benefit you had planned for them may be unintentionally exposed to claims from future creditors.

An ILIT or other trust can be used to protect the insurance proceeds or death benefit by including a ?spendthrift trust? provision that prohibits trust beneficiaries from pledging the trust assets, including life insurance proceeds, as collateral. Their creditors are then only able to reach distributions made directly to them from the trust.

How much Will Your Beneficiaries Need?

A trusted financial advisor can help you determine how much life insurance your loved ones will need so they can enjoy a financially secure future. There are several factors that should be taken into account, including your current total income (from all sources), investments, savings, other insurance policies, potential education and other future expenses, your total debt (including your mortgage), as well as the number and ages of individuals who are financially dependent on you. It is vital that you establish a reliable and secure safety net, as well as provide much-needed financial stability during the transition period immediately following your death. This is particularly true if you are the main income earner, and your spouse is the primary caregiver for your young children but will need to return to the workforce.

Let Us Help

A team approach can be invaluable as you navigate these crucial life insurance questions. Not only can you check with us at JDB Law, you should also communicate with your financial advisor, to make sure that you have contemplated the many possibilities when it comes to life insurance policies and beneficiary designations. We can assist you as you decide the best way to protect your loved ones if you pass away by carefully determining who you should name as your beneficiaries, including whether or not it would be wise to designate a trust to be the primary beneficiary, as well as how much insurance to acquire. If you already have life insurance, or are looking to create or update your estate plan, we can provide advice as you review and update your beneficiary designations. We look forward to witnessing the peace of mind you gain when you take the steps necessary to ensure the financial security of your family.

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