How Will You Leave Life Insurance to Your Children?

If you decide to purchase life insurance for the benefit of your children, you need to arrange some legal means for the proceeds to be managed and supervised by a competent adult. If you don't, and your children are not legal adults when you die, the court will appoint a property guardian for the children. That process necessitates attorneys' fees, court proceedings, and court supervision of life insurance benefits -- costs and hassles that surely won't help your kids. There are several ways to prevent this:

• You may not want to name minors as beneficiaries of your life insurance policy. Instead, name a trusted adult beneficiary who will use the money for the children's benefit. If you are confident that this adult will not waver from his or her duty, even years down the line, this might be the easiest option.
  
  
• You can name your children as your life insurance policy beneficiaries and also name an adult custodian under your state's Uniform Transfers to Minors Act. Most insurance companies permit this and have forms for it. If you want the proceeds to go to more than one child, you'll need to specify the percentage each one receives.
  
  
• If you have a living trust, you can name the trustee as the beneficiary of the life insurance policy. In the trust document, name the minor children as beneficiaries of any money the trust receives from the insurance policy. Also establish within the trust a method to impose adult management over the proceeds, which can be either a Uniform Transfers to Minors Act (UTMA) custodianship or a child's trust. You'll need to give a copy of your living trust to the insurance company.

UTMA Custodianship vs. Child's Trust

There are a few important differences between leaving life insurance benefits to your children under the UTMA and through a child's trust:

• Age when proceeds are released. In most states, an UTMA custodian must turn the proceeds over to the child at an age specified by law -- 18 or 21 in most states, up to 25 in just a few. In contrast, with a child's trust, you can specify any age at which your child receives the proceeds.
  
  
• Reporting requirements. A trustee for a child's trust must file yearly income tax returns for the trust. An UTMA custodian need not file tax returns, although the minor must file a yearly return reporting money actually received.
  
  
• Tax rates. Trust income tax rates are higher than individual tax rates. Annual income above a certain amount in a child's trust is taxed at the higher trust tax rates. In contrast, all of the property subject to the UTMA is taxed at the child's individual tax rate.
  
  
• Ease of fulfilling property management duties. Because the UTMA is built into state law, financial institutions know about it and are comfortable with it. This should make it easy for the custodian to manage the insurance proceeds on behalf of the child.

Generally speaking, an UTMA custodianship is the most attractive option unless the amount of insurance is very large and the child will need a property manager past the age of 21. The UTMA custodianship is simpler to set up and manage -- and often cheaper (from a tax point of view) -- than a child's trust. An UTMA custodianship is particularly sensible for proceeds below $100,000. Amounts of this size often are expended fairly rapidly for the child's education and living needs, and are simply not large enough to tie up beyond the age of 21. If larger amounts are involved and you do not believe the child will be able to responsibly handle the money at the UTMA age limit, a child's trust is a good bet.