If you’ve invested in life insurance to protect your children’s future in the unfortunate event of your death, you might want to consider a trust to hold the money for them. Trusts aren’t only for the wealthy; they can be a useful tool for young families as well.

A trust holds assets, including property and money, for young beneficiaries such as children. You decide how the assets are managed and used, and you can appoint a trustee to oversee the process.

Here’s how they apply to life insurance: When opening a life insurance policy, instead of naming your children as beneficiaries, name the trust and trustee. If you pass away, the trustee will manage the trust according to the rules you set.

Be careful when naming beneficiaries

What is the danger in simply naming your children as beneficiaries of your life insurance policy? If you do meet an untimely end while your kids are still minors, the life insurance company cannot pay out any benefits until the court appoints a guardian, costing time and money for court costs and attorney fees.

Another option is to name an adult custodian to manage your kids’ inheritance under the UTMA, or Uniform Transfers to Minors Act. Your life insurance agent can assist in setting up a UTMA account and name a custodian when buying a policy. Similar to a trustee, the custodian will supervise the money until your children reach legal adulthood. At that point, your kids will receive whatever cash is left.

Advantages of a trust

If you have a small policy, passing on a lump sum could work. But there are potential risks in an 18- or 21-year-old receiving a large lump sum. Even if your children are responsible individuals, they likely do not have the experience necessary to make fully informed decisions, leaving them vulnerable.

A trust provides more flexibility than the UTMA transfer. For example, you can arrange for a trust to pay your children’s upkeep and college tuition costs. It could then distribute portions of the remaining money at specified times, like their 25th and 30th birthdays.

Types of trusts

Trusts can be revocable or irrevocable. Revocable trusts can be changed, or even ended, during your lifetime, while irrevocable trusts cannot be undone. Wealthy people use irrevocable trusts to protect heirs from estate taxes, and property within them is generally not included as part of an estate for tax purposes. Federal estate taxes currently only apply to estates valued at over $5.43 million per person and $10.86 million per married couple. These values change annually depending on inflation rates. Unless you are very wealthy, a revocable trust will probably suffice.

It is important for families to meet with someone with experience when discussing all aspects of a financial plan before fully committing to them. Once a plan is in place it can be difficult to revise, so it’s best to get it right the first time.

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