A Huge Financial Mistake Many New Parents Make

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As a parent, you want the best for your children. You don’t want to think about it, but this involves making sure they’ll be financially covered in the event of your untimely death.

Chances are, as soon as your new bundle of joy was born, you added them as a beneficiary on your life insurance policy. Your heart was definitely in the right place, but you might be surprised to learn taking this step is actually a big mistake.

Why To Think Twice Before Making This Move

“Every parent wants to ensure that their children are provided for in the event of their death, but naming a child as the sole beneficiary of a life insurance policy is one mistake parents do not want to make,” said Colleen Carcone, J.D., CFP, director of wealth planning strategies at TIAA.

She said this is a mistake for two reasons, the first being they’re not allowed to directly receive the payout by law.

Make Your Money Work for You

“Legally, an insurance company cannot deliver death benefit proceeds to a minor child,” she said. “Life Insurance payouts, no matter the amount, can be a lot to manage for adults, much less children.”

She said if a child is listed as the beneficiary of a life insurance policy, and there is not a surviving parent or listed guardian, a court-appointed guardian will need to be provided to receive the funds on behalf of the minor. The court will then determine how the funds will be distributed.

“This may cause a delay in delivery of the funds that may be necessary for the child’s support,” she said. “This will be further compounded if the deceased parent did not name a guardian for the minor child, or, if there is not a surviving parent.”

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She said the other reason naming your child as the beneficiary of your life insurance policy is a bad move is it can give them access to too much money at a young age.

Make Your Money Work for You

“When the child reaches the age of majority — as defined by the state in which the child lives — the proceeds will become his,” she said. “Often clients are uncomfortable thinking about their 18-year-old child receiving unfettered access to cash.”

She said one reason for concern is someone that age might not have the maturity or skills to manage money, leading them to squander it.

“And finally, if that child has special needs, receiving cash could disqualify them from any needs-based benefits,” she said.

As a solution, she said you can leave assets to a trust for a child, instead of leaving it to them directly.

“There are a number of advantages to leaving assets to a trust for a child,” she said. “Specifically, the Grantor or person making the trust can determine how the assets are to be used, who should manage the assets and can ensure that the assets will be available for the desired purposes.”

When creating a trust, she said the Grantor can decide the distribution age, trust terms and trustee(s) assigned to the account.

Make Your Money Work for You

“The Grantor will want to think carefully about who they name as a trustee,” she said. “The trustee should have financial acumen, in addition to the time and desire, to perform the necessary duties.”

She said you can also appoint a co-trustee.

“By naming a corporate trustee as a co-trustee, your surviving spouse or other loved one can handle the personal decisions of your trust, while the corporate trustee can handle all of the business affairs of your trust estate,” she said. “In addition, continuity and professional management of assets will preserve the most wealth for your descendants.”

An Alternate Type of Support

Leaving life insurance assets to a trust isn’t the only way you can provide for your children in the event of your untimely death. Michael Collins, CFA, a professor at Endicott College in Beverly, Massachusetts, said you could also consider setting up an education savings account, such as a 529 Plan.

“This type of account is designed to help parents save for their children’s post-secondary education and is exempt from federal income tax,” he said.

Make Your Money Work for You

No matter what route you take, it’s important for parents to explore options that can provide long-term financial benefits for their children, said Collins, who is also the founder and CEO of WinCap Financial.

Hopefully, the precautions you take to financially safeguard your children in the event of your untimely death will not need to be used. However, taking the right steps now will ensure they’re protected and provide you with peace of mind in knowing they’ll be financially secure no matter what.

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About the Author

Jennifer Taylor is a West Coast-based freelance writer with more than a decade of experience writing about anything and everything. Since earning her MBA, personal finance has been her favorite topic, as she’s passionate about writing stories that educate, inform and empower. Specifically, she specializes in budgeting, debt repayment, savings and retirement.
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