Life insurance is an important resource working parents have to give their children financial protection. Yet over 60 percent of single parents in the country remain uninsured. Those who do are often unaware that children cannot receive money from an insurance company.
If an unexpected death takes place, part of the money will be spent in court appointing a custodian. However, this can be avoided by setting up a life insurance trust. In this article, we discuss what is a trust, how to set it up and things to consider along the process.
Single parents must be careful when choosing the beneficiary of a life insurance policy
Life insurance policies require a beneficiary, which is a person or legal entity designated to receive the money when the insured party dies. Married couples often choose the other parent as beneficiary when purchasing individual life insurance policies.
This arrangement does not work for single parents. A common mistake made by single parents is to name their children as beneficiaries. However, if their children are underage they will not be able to claim the payout in case of an unexpected death. Instead, a court will have to appoint a custodian to manage the money until they reach adulthood. This process takes time and is very expensive, reducing the amount of money available to children.
The Uniform Transfers to Minors Act, known as UTMA, was designed to address this problem. The legislation allows parents to name an adult custodian to manage the money until the surviving children reach adulthood. Most insurance companies allow policyholders to set up an UTMA account and name a custodian when buying a policy. However, this solution doesn’t work for single parents without immediate relatives whom they can trust to manage their children’s inheritance.
Life insurance trusts have many advantages, and choosing the right type is an important step
Single parents with life insurance policies of less than $50,000 might consider it unnecessary to set up a trust. However, parents with higher coverage amounts can take advantage of a trust to manage their children’s future responsibly. The main advantage of a trust over systems like UTMA is that it allows parents to determine how insurance money will be spent. There is no need for a custodian, and the children will save money otherwise spent in court costs and attorney fees.
In general, trusts can be revocable or irrevocable. Revocable trusts can be modified or finished during a parent’s lifetime. Irrevocable trusts are untouchable once set up. People with considerable wealth prefer irrevocable trusts as they protect money from estate taxes. However, most families use revocable trusts because of their flexibility. If the trust is no longer needed, the family can reclaim the money and repurpose it.
Parents whose children have a disability may want to set up a special needs trust. To qualify for government assistance, disabled children cannot have more than $2,000 in assets to their name. A special needs trust is not counted towards the threshold. As a result, single parents can put life insurance money into a special needs trust named to their children without losing access to critical services such as Medicaid and SSI.
Attorneys like Scott Malin of Lathrop & Gage LLP agree that parents with minor children should always set up a trust. Life insurance is an important resource when protecting the future of children, but a mismanaged policy contract can put their finances at risk. Getting professional advice to set up the most efficient life insurance trust is an important step to guarantee that children are prepared if an unexpected death takes place.