You can make a lot of mistakes with life insurance. But none is worse than bungling the beneficiary.
Without expert help, you could create a financial disaster after you die. I’m not an attorney, and this is not legal advice. But it’s a starting place for discussion with trusted professionals.
Here are five “beneficiary bungles” that come to mind:
1. Not specifying the exact beneficiary.
If you name “my family” or “my kids” as the beneficiary, you are risking chaos after you die. Families change. People change. If you name a person or persons as the beneficiary, always use complete names, dates of birth, and other identifying information.
2. Not having back-up beneficiaries.
If your beneficiary is a person, and you and they are both killed in the same accident, the death benefit will go to your estate. And you really don’t want that. (See number 3.) So always have two contingent (back-up) beneficiaries.
3. Naming your estate as the beneficiary.
Estates are subject to federal inheritance taxes.
But that’s not all. Estates are also subject to claims from creditors and others.
And estates often get tangled up in probate court for years before anyone sees any money. Never name “my estate” as the beneficiary.
4. Naming a minor child as the beneficiary.
Don’t do this.
California, like most states, will not allow a minor child to directly receive life insurance proceeds. Instead, a court will appoint a trustee to handle the money for them.
You don’t want that. This is where a well-written trust can be the best option. In a trust, you can explain exactly how the money should be used for the kids.
If you don’t want to set up a trust, at least designate the custodian of the money, using the Uniform Transfers to Minors Act (UTMA). It’s relatively simple to do.
5. Creating the “unholy trinity” tax trap.
Technically, this is known as the Goodman Trap or the Goodman Triangle named after a famous 1946 court case.
When the policy owner, the insured person, and the beneficiary are three different people, the IRS will look at the death benefit as a gift and tax it. Here’s how that works:
Sarah has a disabled child with ongoing medical bills. So, she buys a life insurance policy on her husband, Bill, and then names her son, Alec, the beneficiary.
It makes perfect sense, right? If Bill dies, she will have a harder time taking care of Alec’s medical bills. And she wants to make sure that the money is understood to be for Alec, not anyone else.
Bill died one day. The death benefit was paid to Alec, and the court appointed Sarah the trustee of the money.
Weeks later, the IRS sent her a notice. She owed a gift tax on the money that Alec received. The IRS viewed the money as a gift that she (the owner) gave to her son (the beneficiary). It was taxable.
My advice:
Don’t do this alone.
First, consult with an experienced life insurance agent before naming a beneficiary.
Second, consult with an attorney who specializes in the areas of estate planning, probate, and trusts.
Life insurance planning is safest when done as a team activity. If you haven’t reviewed your life insurance policies in a while... give a trusted professional a call today.
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