Navigating the financial future of your children is a top priority for any parent, and life insurance can play a crucial role in that planning. However, naming a minor as a direct beneficiary can lead to unintended complications, such as the need for a financial guardianship. A trust holding life insurance for a child can mean saving more and having more control over how your child receives benefits.
In North Carolina, a financial guardianship can be a cumbersome and costly process. This blog will delve into how using a trust for your child can sidestep the need for a financial guardianship, streamlining the inheritance process and ensuring that your child’s financial well-being is secure.
Types of Life Insurance Policies: What You Need to Know
Selecting the right life insurance policy is a critical step in safeguarding your family’s financial future. Various policy types offer distinct features and benefits, so understanding your options is essential. Here’s a rundown of some common types of life insurance and their key characteristics.
Permanent Life Insurance
Offering lifelong coverage as long as you pay the premiums, permanent life insurance policies stand out for their savings component. They allow you to accumulate cash value over time, which you can either borrow against or withdraw for financial needs.
Term Life Insurance
Providing coverage for a set period, such as 10, 20, or 30 years, term life insurance is straightforward and generally more affordable than its permanent counterpart. However, it lacks a cash value feature, and if you outlive the term, you’ll need to either renew the policy or go without coverage.
Universal Life Insurance
A variation of permanent life insurance, universal life insurance offers adjustable premiums and death benefits. It also includes a cash value component that earns interest, providing you with more flexibility to adapt to your changing financial circumstances.
Variable Life Insurance
This type of permanent life insurance allows you to invest the policy’s cash value in various financial instruments like stocks and bonds. The value of your policy can fluctuate based on market performance, offering both risks and rewards.
Death Benefit Essentials
Regardless of the policy type you choose, the death benefit is a central feature. This is the lump-sum amount your beneficiaries will receive upon your passing.
The death benefit can be used for a variety of purposes, from covering funeral expenses to settling debts or serving as an inheritance.
By understanding these different types of life insurance policies, you can make an informed decision that aligns with your family’s needs and your estate planning goals.
Naming an Adult as Beneficiary of a Life Insurance Policy
When an insured person dies, their life insurance benefits payout to the named beneficiary.
Many times, life insurance policies will name multiple beneficiaries. Whether the policy is a permanent life insurance policy or whole life insurance, the life insurance proceeds go to the named beneficiaries.
As long as the life insurance policy is current, beneficiaries receive a guaranteed death benefit when the insured person dies.
Protections in North Carolina
In North Carolina, as long as the policy’s proceeds go to a life insurance beneficiary that includes spouse or children, and not to your estate, the state protects the death benefit from creditors.
Even if you drain your bank account and die penniless, the probate court will not demand the cash value of your life insurance policy to pay taxes or debts.
For example, let’s say you made a risky investment and lost your retirement funds. Then, you spent a year in assisted living, covered by Medicaid. When you pass away, Medicaid Recovery comes looking for payback from your estate along with the rest of your creditors. They are a creditor in probate court waiting for your estate to pay them back for the money spent on your care.
However, because your life insurance policy goes directly to your beneficiaries, Medicaid can’t take that money as a repayment. They can’t come after your family for that money either.
Working with your estate planning attorney can help ensure that your estate plan acts to preserve family wealth and keep your life insurance money safe from creditors.
Why Naming a Child as Beneficiary of Your Life Insurance Policy Is Often a Bad Idea
If your child is still a minor when they receive the benefit of your life insurance as your beneficiary, there are additional steps involved.
Let’s see what those 6 steps include:
1- The Court Appoints a Financial Guardian for the Child
Someone else must go to court and receive an appointment to manage that money for them. The court may appoint a family member or someone you’ve never met.
2- Appointed Financial Guardian Must Buy an Insurance Policy
Whoever the court appoints must then use some of the money to go buy an insurance policy to mitigate the loss if the financial guardian were to steal the money.
3- Your Child’s Insurance Benefits Pay the Insurance Premium (Surety Bond)
Because the policy is expensive, the insurance company receives a lump sum premium to be paid from the beneficiary’s inheritance. The premium that gets paid to the insurance company is so that the insurance company will serve as a “surety” and will repay the stolen money back into the beneficiary’s estate if the court does not appoint a trustworthy guardian, and the person they appoint steals the money.
The paid premium ensures the insurance can pay the child if the appointed person steals it. However, the premium for this coverage against the possibility of theft is very expensive. And the person who pays is your child.
4- Financial Guardian Must File an Inventory With the Court
But even after the appointed person spends your child’s money to get the surety bond, they must file an inventory with the court showing:
- All of the assets that are under their control as financial guardian, including how much money there is and where they keep the money.
- Supporting documentation
5- Financial Guardian Must File an Account with Documentation With the Court EVERY Year
The appointed person must file an account every year in court showing proof of everything they’ve done for the entire year. If they paid a bill, they must have the bill and proof of correct payment. The court meticulously audits every document.
6- Professional Help for the Guardian (from Your Child’s Benefits)
It can be difficult for the appointed financial guardian to handle these audits each year. They may need to use the child’s money to pay for professional help in addition to the court fees.
Now that we’ve seen the steps involved in leaving an insurance policy to your child, let’s look at additional problems that come up.
Problems with a Lump Sum Award to an 18-Year-Old
Our state system in North Carolina means to protect the child and the money, but some serious downsides to this system are obvious.
The first issue is privacy. Even though these financial guardianship files involve children, you can go to a courthouse and pull these children’s files.
You can learn all kinds of things about a child under financial guardianship, including:
- The amount of their assets
- When they will turn 18 years old
And if these files become electronic in the future, the entire state could potentially have access to your child’s information just by searching by name! They may be capable of accessing financial records and many more details.
We don’t know how the future of our state systems will play out. But right now, you CAN walk into a courthouse and get information about a child under financial guardianship and crucial details about their inheritance, and in many counties, you can already access files electronically.
Is an 18-Year-Old Ready to Receive a Lump Sum Payment?
In North Carolina, when a child has a guardian for their death benefits from insurance, the court oversight and financial guardianship ends when the child turns 18.
At this point, the court gives the money (what’s left after all expenses) to the child at the tender age of 18. There is no court oversight on how your child will spend this money. It can be detrimental for a child who is not ready to receive a lump sum of thousands of dollars.
The court doesn’t ask if the child is too immature or has an addiction or other issue that makes giving them a large amount of money a bad idea. An 18-year-old may or may not be responsible.
However, in your case, your 18-year-old lost their parents while still a child. They suffered loss and trauma during their formative years and may not be ready for a large inheritance all at once. They could do something dangerous or reckless with their inheritance.
So, to sum up, leaving money to a child beneficiary can cause issues such as:
- Surety bond premiums that drain your child’s insurance benefit
- Court fees
- Professional fees
- Court interventions, inventories, and audits
- Privacy concerns (and potential scammers coming at your child right at the tender age of 18)
The Solution For Child Beneficiaries
If you have minor children, you can instead create a legal tool that holds the money for your child and distribute it to them at the age you choose and in the amounts and times you choose.
A trust can provide legal and financial security for your child without a need for financial guardianship.
Trusts are a legal framework, almost like your own personal business. The trust holds the money for your child’s benefit and gives them the money according to your trust documents.
When you create a trust, you name a trustee who will handle the money and eventually distribute assets to your child. Your trustee does not report to a court that acts as a financial advisor or oversight for your child’s money. However, a trustee is by law responsible for properly handling the money and property in a trust fund.
There are different kinds of trusts, and depending on your situation, one trust might be better than another. But generally, a trust is a good mechanism because you can create an entity that follows your rules. You can make rules and conditions about what the trustee can and can’t spend money on for your child.
A trust gives you the control as a parent to direct where the insurance money will go. Your trustee handles the trust funds as you see fit for your child’s best interests.
Instead of complicated steps with court oversight, your trustee can take one simple step:
One Simple Step to Receive the Inheritance
The Trustee Fills Out Insurance Claim Paperwork and Receives the Death Benefit Into the Trust. The trust is eligible to receive all of the money with no surety bond because it is a trust managed by the trustee of your choosing. It is not a minor child.
And there are no worries about privacy because the court is not involved. The death benefit goes directly into the trust. There is no waiting for a court audit or problems with spending on what your child needs.
Create a Conditional Trust Document
You may create conditions in your trust documents that determine when your child receives the death benefit.
You also may name multiple beneficiaries who all benefit in the amounts and ways you describe in trust documents. Your financial plan in creating a trust as an intervening step protects your child’s privacy and security.
A trustee can get things done very quickly compared to a guardian working with the court system.
In a guardianship, the court exerts control over how the money is spent. A court can really really get into the weeds on how this money is spent or what it’s spent on. A guardian is subject to the whims of the court and other judicial employees.
However, with trusts, the trustee has the flexibility to allow what is best for your child based on your own trust documents. With a trust to hold life insurance death benefits, you can call the shots on how the money is used for your beneficiaries long after you’re gone.
Life insurance trusts allow you to decide the answers to these questions:
- What things are important to you?
- What things do you want to prioritize?
- Is your child’s education a priority?
- Do you want them to enjoy an allowance?
- When will they inherit money, and how much at a time?
Some parents will lay out trust conditions that the child receives a lump sum at 25. The trustee will manage the money for the child at their discretion until this time.
Others may let the trustee manage the money until a child is 30. With life insurance trusts, you know that this money is laid out to work for your child’s benefit. You can set up the trust to pay for particular things they need or want but at the discretion of a trustee.
Your trustee is someone who’s older, more mature, and whom you’ve already gotten to see in action living their life. And since you select your trustee, you can feel good that someone more responsible than your 18-year-old will manage the funds for your child’s benefit.
Our Experienced Estate Planning Attorneys Can Help
At Hopler, Wilms, and Hanna, our knowledgeable estate planning attorneys help you fully understand trusts and how to prevent financial guardianships for minors in North Carolina. We understand that every family’s needs are unique, and we tailor our services to meet those specific requirements.
Whether you’re considering a Trust for your child to avoid the hassle of a financial guardianship or exploring other estate planning tools, we’re here to provide expert guidance every step of the way. Our goal is to help you create a comprehensive estate plan that offers financial security and peace of mind for you and your loved ones.
Get in touch with us today and start planning for your family’s future.