Life insurance plays a crucial role in most families' estate and/or financial plans. Because of this, it's'important to ensure your insurance policies are set up correctly. Making one of these ten common mistakes can derail an otherwise flawless plan, resulting in a failure to accomplish your goals, creating problems for the next generation, and possibly jeopardizing the relationships between your heirs.
1. Naming a Minor Child
Life insurance carriers won't pay a life claim directly to minors. If you haven't made other arrangements via a trust or Will, the court will appoint a guardian - a costly process - to handle the money until the child reaches the age of majority in your state.
Instead, consider whether there is a reliable adult that can inherit the funds and manage them for the child, or set up a trust to benefit the child and name the trust as the beneficiary of the policy. Another option would be to name an adult custodian for the life insurance proceeds under the Uniform Transfers to Minors Act. If necessary, consult an estate attorney to decide the best course.
2. Forgetting you Live in a Community Property State
While it's possible to name anyone with whom you have a relationship as your beneficiary, in a Community Property state you will typically need the spouse to sign off on the designation of any non-spouse, primary beneficiary.
These are all Community Property States:
3. Assuming the Will supersedes the Policy
Many assume their Will will govern the distribution of their life insurance proceeds. But life insurance is a contract. Regardless of what the Will says, the life insurance benefits will be paid to the beneficiary named in the contract.
4. Accidentally Disqualifying a Beneficiary from Government Benefits
Naming a child with special needs, or other lifelong dependent, as the beneficiary can put them at risk of losing government assistance.
Instead, consider consulting an attorney to help you set up a special needs trust, and name the trust as beneficiary.
5. Voiding the Tax Advantages of Life Insurance
Usually death benefits are income tax free. However, in a situation where three different people are the owner, insured and beneficiary - such as a wife owning a husband's policy, with their child named as beneficiary - the death benefit could count as a taxable gift to the beneficiary.
6. Only Naming a Primary Beneficiary
You may want to simply name your spouse as beneficiary and will not have given any thought to what happens if you predecease your spouse, or even if something were to happen to both of you at the same time.
When there is no living beneficiary, the life insurance benefit typically goes into the estate and is subject to probate. That leads to two complications. One, heirs might face a long wait to get the money. Two, the life insurance proceeds, which normally would be protected from creditors, can now be open to creditors' claims.
Always walk through the thread of beneficiaries from primary to contingent, to final, and make sure you are leaving no gaps.
7. Keeping it a Secret
It's always important to make sure the next generation is aware that an estate plan exists. This gives you a chance to make sure your wishes are fully understood, heads off any confusion, and makes sure that the beneficiaries know there is a policy, and where to find it.
We've all heard that the best life insurance policy to own is the one that pays when you die. Make sure your heirs benefit from your hard work.
8. Forgetting to Update
Naming a beneficiary is not a "set it and forget it" event. Beneficiaries die, second and third marriages occur, or your wishes may simply change. If you have a life insurance policy collecting dust, pull it out and double check your beneficiary designations.
9. Attaching No Strings
Naming young-adult children as beneficiaries of large sums of money can be a recipe for financial disaster. What 18-21 year old can handle an influx of a million dollars in cash?
Consider the possibility of establishing a trust that lays out the specifics of how the money can be used until the beneficiary reaches a certain age.
10. Neglecting Details
Your life insurance policies are legal contracts - make sure they are worded correctly. Rather than naming "Children of the Insured" as beneficiary, it's preferable to list them by name, with social security numbers and addresses. This ensures that the beneficiaries can be located, identified, and helps preclude surprise beneficiaries.
Also indicate whether the children should inherit "per stirpes" or "per capita".
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