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The use of life insurance can be an excellent option not only as an investment tool, but also as an intricate part of an individual’s estate plan. Should an individual choose to purchase a life insurance policy, careful attention must be taken when designating the beneficiary.
Below are 5 mistakes to avoid when designating a life insurance beneficiary.
- Naming a beneficiary who receives government benefits that are means tested
An individual on a means tested program can only maintain eligibility if they do not have too many assets titled in their name. In the event they are receiving means tested government benefits and is named as a beneficiary of a life insurance policy, they will likely lose their government benefits.
A solution to this issue is to designate a Special Needs Trust as the beneficiary instead of the individual. This will avoid a forfeiture of benefits.
- Naming a minor as a beneficiary
Designating a minor as the beneficiary of a life insurance policy is often done with the greatest intention of providing for an individual’s child or children. First, designating a minor as a beneficiary will result in court involvement upon the owners passing, which may result in significant legal fees and time delay. Further, the owner will lose their ability to safe guard the proceeds until the owner feels the child is fit to receive a large sum of money. A solution would be to leave the proceeds in trust for the benefit of the minor child.
- Inadvertently failing to name a beneficiary on the life insurance policy
When an individual first purchases his life insurance policy, one would generally designates a beneficiary at that time, often their spouse. After several years, the spouse may have passed away or their intentions may have changed, and he/she may forget to update the beneficiary designation. It is important to remember that generally life insurance is income tax free but may be subject to estate taxes.
Also, it is important to be mindful that if a Trust owns the life insurance policy, unless the Trust is also named as the beneficiary, the terms of the Trust may not be carried out. It may also cause the life insurance proceeds to be subject to estate taxation.
- Failing to designate the correct beneficiary
If the owner is designating a Trust as the beneficiary, they must be cognizant of designating the correct Trust. Designating the wrong Trust may result in unintended beneficiaries of the estate or an imbalance in the estate distribution. One must be careful to use the formal name of the trust as the beneficiary including the name of the trustees and the date of the trust agreement.
- Failing to designate a beneficiary in the most protective manner
If the beneficiary of the life insurance policy is an individual, careful consideration must be given to the potential consequences of leaving an asset outright to an individual.
Leaving the life insurance proceeds outright to an individual can result in risks that involve exposing the proceeds of the policy to the third party influences of the beneficiary (ie, death, divorce, creditor, misappropriation). A more protective approach would be to establish a Trust that protects the beneficiary, sometime referred to as a “Family Protection Trust” or “Safe Trust”.
It is important to consult with an estate planning attorney, as well as a financial planner and an accountant when naming your beneficiaries on your life insurance policy.
By Kim N. Christian– Guest Blogger