good intentions, bad results
October 13, 2014 - Posted by: admin - In category:
I was recently working with some parents of young children. These were dutiful and devoted parents in all respects. As part of their careful planning, they had purchased various life insurance policies and had executed Wills to appoint guardians for their young children, in the event that something should happen to both parents. These parents were wise enough to recognize that if something did happen to them, the life insurance companies would NOT pay the policy proceeds to the minor children and they had named the proposed guardian of their children as the direct beneficiary of their life insurance policy. Good planning, right? These wonderful parents did much that was right in their planning, but a few recommended changes would better carry out their overall goals and would give better protection for all people, especially their young children.
Lets look at the worst case scenario–namely the death of both parents and the life insurance proceeds being paid directly to the appointed guardian of the young children. When the check arrives from the life insurance company, it is made out to the name of the guardian. This means that this money is the property of this guardian–plain and simple. Now, the hope is that this guardian will honor the wishes of the deceased parents and use the money for the benefit of the minor children for whom the life insurance proceeds were intended. However, with a simple Will that appoints guardians for minor children on one hand and a separate beneficiary designation that leaves the life insurance proceeds outright to and in the name of the appointed guardian–there is a gap. While it may seem logical to expect that having these two unrelated planning devices in place (i.e. the simple Will and the life insurance) would be adequate to carry out the aim of providing for the care of the young children, the legal reality is that the simple Will and the outright payment of life insurance proceeds to the name of the guardian leaves a gaping hole and several potential dangers and problems.
Problem #1 is the simple reality noted above that the life insurance proceeds belong to the guardian. It is his/her money. Therefore, should the guardian have a change of heart, get into financial difficulties and/or become subject to lawsuit or other circumstances, this money could very well end up in other hands and be used for purposes totally unrelated to the care and maintenance of the children for whom it was intended. In fact, just the simple process of the guardian depositing the life insurance into his/her checking account (one that is accessible by the spouse), could open yet another “can or worms”, including a possibility that the spouse might have a change of heart, want to buy a new car, etc. In short, this is just NOT a risk that is worth taking, especially when it is the young children in this scenario who stand to suffer from the outcome.
Problem #2 is related to the first problem–namely, in the event that the guardian dies, is divorced and/or becomes disabled, it is almost certain that the life insurance proceeds will end up in the hands of people other than the young children.
Problem #3 is tax related. While it is true that life insurance proceeds are not generally subject to income taxes, this money IS subject to estate taxes and other tax considerations. Certainly no one desired or intended to create more tax issues for the person being appointed guardian of the minor children–but this could be the actual result of this type of planning.
So what is the solution to this “worst case” scenario? There are various options, but some of the most simple and most commonly used options involve the usage of one or more trusts–either “living” or “testamentary”. In other words, these fine parents could revise their Wills to establish a trust for the benefit of their children (a testamentary trust) or they could act now to establish a trust while they are living (hence, the term “living trust”). In either scenario, the parents would then change the beneficiary designations with their life insurance companies so that the proceeds are payable to the trustee of the trust, rather than outright to the appointed guardian. Practically, this would result in little change, but the LEGAL ramifications would be VERY different.
In other words, if the suggested changes were made and the life insurance proceeds were paid to the “trustee of the trust”, such proceeds would then be held, managed and used by the person appointed as trustee (normally the same person appointed as guardian in these circumstances). Then, if the trustee/guardian were to run into financial issues, file for divorce, die and/or become disabled, in each of these circumstances, since the life insurance proceeds would then be a “trust asset”, such funds would NOT be considered personal property of the trustee/guardian. Therefore, the life insurance proceeds would continue to be protected and reserved for the care of the young children. Any proper trust, whether a living trust or a testamentary trust, would provide for a successor trustee, and this successor trustee would then assume control of the life insurance funds when needed.
While this is admittedly “worst case” planning, it is wise to engage in such contingency planning. You and I wear seat belts, drive cars with airbags and buy auto and life insurance as part of this very same “worst case” planning. Even though it is highly unlikely that we will ever need such insurance/seat belts and/or airbags, we recognize the catastrophic consequences that could result in the absence of these things and we therefore live with greater peace of mind (and sleep much better) by incorporating these things into our lives. The same “better safe than sorry” approach is warranted when we are looking at estate planning generally and ESPECIALLY with regard to planning for the protection and care of young children.