The proceeds from life insurance policies are often the single largest cash asset available for the continued support of a surviving spouse and children. However, once purchased these policies tend to become invisible and neglected assets that accumulate dust with other “valuable papers”.
Properly updated and well conceived beneficiary designations are a key component to any generational planning system. Overlooking this simple planning strategy can render an otherwise well drafted Will or Trust tragically ineffective. The following unintended consequences highlight the contractual nature of life insurance.
SITUATION 1: Husband designated Wife as primary beneficiary of his life insurance policy and designated his older brother as the contingent beneficiary “just for now”. A few years later, Husband and Wife were killed in a car accident leaving two minor children.
Problem: The life insurance proceeds were contractually paid to the older brother who commingled the funds in accounts with his wife and “borrowed” a portion of the funds to buy a new house.
Unintended Consequence: The brother’s wife received one half of the house and one-half of the remaining proceeds in a final decree of divorce, successfully claiming that the funds had been converted to community property.
SITUATION 2: A recently divorced mother purchased a new life insurance policy naming her minor son as the primary beneficiary to ensure that he could go to college if anything happened to her. She died in a hiking accident when her son was 10 years old. The estranged father was appointed guardian of the minor son.
Problem: Life insurance proceeds cannot be paid directly to a minor so the father was also appointed guardian of the estate for the purpose of managing the proceeds. The father and son continued a strained relationship
Unintended Consequence: The law in Texas provides that a guardianship shall be closed when the ward “is no longer a minor”. The son turned eighteen and received $750,000 in cash one week after graduating from high school and said, “Who needs college? I'm out of here”.
SITUATION 3: Husband designated his wife a primary beneficiary of a $2M policy without naming a contingent beneficiary. Husband was at fault in a head on collision that killed his wife and the driver of the other car instantly. Husband was in a coma for several weeks before passing away. They had two minor children.
Problem: Husband had not named a contingent beneficiary which required the life insurance company to pay the proceeds to his “estate” thereby subjecting them to the probate process and claims of creditors.
Unintended Consequence: A wrongful death law suit was filed against the Husband’s estate by the family of the other driver. A judgment against the Husband’s estate exceeded his available liability insurance coverage, such that all of the $2M life insurance proceeds were paid to the family of the other driver. The Husband’s children received ZERO.
SOLUTION: These adverse consequences could have been easily avoided in a three step planning process.
INTENDED RESULTS: The life insurance company will pay the proceeds to the contractually designated trustee of the Trust. The proceeds will be protected from the creditors of the parents, trustee, guardian, and the children. The income and principal would be provided to the health, education, maintenance and support for the children. To avoid a large lump principal payment at 18, the Trust could provide for a gradual distribution to the children at predetermined ages, such as 25, 30, and 35.
© Will Morris, JD, LLM 2014